The Circular-Flow Diagram is an economic model that graphically shows the transaction within an economy by flows around a circle. It is a very simplified representation of reality, but, at the same time, it is very useful.

The two "inhabitants" :

1. Households: a person or a group that share income
2. Firms: an organization that produces goods and service for sale

The two markets:

1. Product Markets: this is where firms sell goods and services to households
2. Factor Markets: this is where firms buy factors of production (things that are not used up in production, such as labor, land, capital, and human capital)

The two flows:

1. Physical things (black arrows): Inputs supplied, Inputs demanded, Goods supplied, and Goods demanded
2. Money (grey arrows): Incomes, Expenditure, Revenue, and Costs
   

Economic Models | Production Possiblities Frontier | Comparative Advantage | Circular Flow Diagram | Uses of Economic Models