Two Sectors, Two Markets

• Household Sector: This includes everyone, all people, seeking to satisfy unlimited wants and needs. This sector is responsible for consumption expenditures. It also owns all productive resources.
• Business Sector: This includes the institutions (especially proprietorships, partnerships, and corporations) that undertake the task of combining resources to produce goods and services. This sector does the production. It also buys capital goods with investment expenditures.

• Product markets: This is the combination of all markets in the economy that exchange final goods and services. It is the mechanism that exchanges gross domestic product. The full name is aggregate product markets, which is also shortened to the aggregate market.
• Resource markets: This is the combination of all markets that exchange the services of the economy's resources, or factors of production--including, labor, capital, land, and entrepreneurship. Another name for this is factor markets.

Circulating Around

The Basic Circular Flow

• 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

• 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

• 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.