In the circular flow model of a simple economy, which of the following correctly describes the flow between households and firms?

Question

BlackTom AI · Accepted Answer

To analyze the question about the circular flow model, I’ll examine what each option claims about how households and firms interact in the two markets—product and factor markets.
Option a states that households provide goods and services to firms in the product market, and firms pay wages in the factor market. This is incorrect because households do not provide goods and services to firms in the product market; rather, firms provide goods and services to households in the product market, and households pay firms for those goods. The money-flow description is also reversed in terms of who supplies and who pays whom in the product market, making this option inaccurate.
Option b claims that households supply factors of production (labor, land, capital) to firms in the factor market, and receive income in return. This aligns with the standard depiction of the circular flow: households own the resources and sell them to firms in the factor market; firms hire those resources and pay wages, rent, and profits to households, which is the income households receive. This option accurately captures the two-way exchange between households and firms across the markets.
Option c states that households purchase factors of production from firms, who then use this revenue to buy goods and services. This reverses the real flow of resources and money in the model: households do not purchase factors from firms; firms purchase factors from households. Additionally, firms use revenue earned from selling goods to households to pay for those resources, not to fund a separate purchase of goods and services from households.
Option d says that firms supply money to households in the product market, and households provide profits in the factor market. This misrepresents both markets: firms do not supply money to households in the product market in exchange for goods, and households do not supply profits in the factor market; households supply factors, and firms pay income in return. The direction and nature of these flows are inconsistent with the standard circular-flow diagram.
In summary, each incorrect option either reverses who supplies resources versus who consumes them, or misstates which market handles which transactions. The only description that correctly matches the established flows is option b, where households supply factors of production to firms in the factor market and receive income in return.

In the circular flow model of a simple economy, which of the following correctly describes the flow between households and firms?

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