Why is the circular flow diagram useful?

A circular flow diagram represents how goods, services, and money move through our economy. ... Households then offer land, labor, and capital (known as factors) to firms so that they can then produce the goods and services. Households also offer the firms their money in the form of spending when they purchase goods. read more

The circular flow diagram is a basic model used in economics to show how an economy functions. Primarily, it looks at the way money, goods, and services move throughout the economy. In the diagram, there are two main characters, known as firms and households, where households represent consumers and firms represent producers. read more

In general, the circular-flow model is useful because it informs the creation of the supply and demand model. When discussing the supply and demand for a good or service, it is appropriate for households to be on the demand side and firms to be on the supply side, but the opposite is true when modeling the supply and demand for labor or another factor of production. read more