Chapter 10, Problem 2FRQ

To determine

The question requires us to draw a correctly labeled circular flow diagram including the factor market, the market for goods and services, and the government.

Explanation of Solution

The circular-flow diagram without government:

The following graph represents the circular-flow diagram in the market:

  

Firms produce goods and services and sell them into the goods market where households purchase these goods and services and pay money in return. This money is used by the firms to pay in the factor markets to households. Again the money received by households from the factor market will be used by them on purchasing from markets goods and services. This is how a circular flow of money will complete.

1. The green line indicates the transactions of money between firms and households.<
2. The black line indicates the transactions of goods and services and factors of production in the goods market and factor market respectively.

The circular-flow diagram with government:

The following graph represents the circular-flow diagram including households, firms, and government:

  

The money received by households from the factor market will be used by households for consumption and savings. Households pay taxes and save the remaining money in the financial markets from where government and firms borrow. Government receives money in the forms of taxes and borrowings and spends those in the goods and services market. Finally, these transactions generate GDP in the economy and money keeps rotating in the market.

The leaks out of the economy are the private savings while the money leak in the economy is the government spending in the market.

Economics Concept Introduction

The circular-flow diagram represents the flow of money and the transactions of goods and services between firms and households. These transactions happen in the market for goods and services and factor markets.