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October 24, 2014 

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LOCAL INPUT: An input that has a relatively small geographic market area due to the high cost of transportation. The high transportation cost means it is easier (that is, less expensive) to locate the production activity near the input rather than trying to bring the input to the production activity. Like many things, local inputs are a matter of degree. At the other end of the spectrum lies transferrable inputs. Natural resources of the land, such as soil fertility, weather conditions, mineral deposits, tend to have the greatest local orientation. Labor and many urban public utilities, such as water distribution and sewage disposable, also tend to fall into the local category.

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TWO-SECTOR, TWO-MARKET CIRCULAR FLOW:

A simple circular flow model of the macroeconomy containing two sectors (business and household) and two markets (product and factor) that illustrates the continuous movement of the payments for goods and services between producers and consumers. The payment flow between the two sectors and two markets is conveniently divided into four segments representing consumption expenditures, gross domestic product, factor payments, and national income. More advanced models containing additional flow segments are two-sector, three-market circular flow; three-sector, three-market circular flow; and four-sector, three-market circular flow.
The two-sector, two-market circular flow model is the simplest way to show the inherent interrelationship between producers and consumers in the macroeconomy. It illustrates that actions by producers necessarily affect consumers and that actions by consumers necessarily affect producers. In particular, it illustrates that payments do not vanish from the macroeconomy, but are merely passed along. It shows that the expense of one sector is the revenue of another.

Two Sectors, Two Markets

The two macroeconomic sectors included in this model are:The two macroeconomic markets in this basic version of the circular flow are:

Circulating Around

The Basic Circular Flow
Circular Flow


This diagram presents the simple two-sector, two-market circular flow. At the far left is the household sector containing people seeking consumption. At the far right is the business sector that does the production. At the top is the product markets that exchange final goods and services. At the bottom is the resource markets that exchange the services of the scarce resources.
  • Gross Domestic Product: Consider first the upper right-hand segment of the circular flow between the product markets and the business sector. This is the revenue received by the business sector for the production of goods and services, what is officially termed gross domestic product (GDP). Click the [Production] button to illustrate this flow.

  • Factor Payments: Moving clockwise with the flow, the lower right hand segment between the business sector and the factor markets is factor payments. These are payments to the owners of labor, capital, land, and entrepreneurship for the productive services they provide. Factor payments can be divided into specific items depending on the resources involved, including wages, interest, rent, and profit. Click the [Factor Payments] button to illustrate this flow.

  • National Income: Continuing clockwise to the lower left hand segment between the factor markets and the household sector is national income. Definitionally speaking this is the income earned by the factors of production, which are owned by the household sector. Click the [Income] button to illustrate this flow.

  • Consumption Expenditures: The last segment of this flow, between the household sector and the product markets in the upper left hand corner, is consumption expenditures. These are expenditures made by the household sector for the purchase of gross domestic product. Click the [Consumption] button to illustrate this flow.

Circulating Equality

Two points are worth emphasizing:
  • First, the flow between sectors and markets circulates. Gross domestic product is used for factor payments, which becomes national income, which is used for consumption expenditures, which buys gross domestic product, which is used for factor payments, which becomes national income, which is used for consumption, which is... And on it goes.

  • Second, all four segments in this two-sector, two-market circular flow circular flow--gross domestic product, factor payments, national income, and consumption--are equal. The revenue received from selling gross domestic product is used for factor payments. The factor payments become national income. The national income is used for consumption. This consumption is then used to buy gross domestic product... And on it goes.

Other Models

This two-sector, two-market circular flow is a simple model of an exceedingly complex economy. More realistic and more complex models are available. The other models are:
  • Two Sectors, Three Markets: A second version of the circular flow model adds the financial market',500,400)">financial markets to the basic model. This addition illustrates how saving is diverted from the household sector to the business sector to finance investment expenditures.

  • Three Sectors, Three Markets: A third version of the model includes the government sector. This model highlights the importance of taxes, which are also diverted from household sector income and used to finance government purchases.

  • Four Sectors, Three Markets: The most comprehensive circular flow model includes the foreign sector. Adding the foreign sector highlights the role of trade with the rest of the world, especially exports and imports.

<= TWO-SECTOR, THREE-MARKET CIRCULAR FLOW


Recommended Citation:

TWO-SECTOR, TWO-MARKET CIRCULAR FLOW, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: October 24, 2014].


Check Out These Related Terms...

     | physical flow | payment flow | circular flow | two-sector, three-market circular flow | three-sector, three-market circular flow | four-sector, three-market circular flow |


Or For A Little Background...

     | macroeconomic markets | product markets | resource markets | macroeconomic sectors | household sector | business sector | production | consumption | model | market | exchange | economy |


And For Further Study...

     | business cycles | macroeconomic goals | macroeconomic problems | macroeconomic theories | unemployment | inflation |


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