![]() ![]() While the property owners are “independent,” the model demonstrates the mutual interdependence between all the classes of people that Adam Smith dubbed the “ invisible hand” in The Theory of Moral Sentiments (1759). Farm production is exchanged for the goods and services produced in the cities by entrepreneurs and artisans. (2010) further explained:Ĭantillon develops a circular-flow model of the economy that shows the distribution of farm production between property owners, farmers, and workers. Cantillon described the concept in his 1730 Essay on the Nature of Trade in General, in chapter 11, entitled "The Par or Relation between the Value of Land and Labor" to chapter 13, entitled "The Circulation and Exchange of Goods and Merchandise, as well as their Production, are Carried On in Europe by Entrepreneurs, and at a Risk." Thornton eds. One of the earliest ideas on the circular flow was explained in the work of 18th century Irish-French economist Richard Cantillon, who was influenced by prior economists, especially William Petty. History Cantillon Representation of Cantillon's primitive circular flow model Also not shown in this simple illustration of the economy are other aspects of economic activity such as investment in capital (produced-or fixed-assets such as structures, equipment, research and development, and software), flows of financial capital (such as stocks, bonds, and bank deposits), and the contributions of these flows to the accumulation of fixed assets. An economy involves interactions between not only individuals and businesses, but also Federal, state, and local governments and residents of the rest of the world. Of course, the total economy is much more complicated than the illustration above. The circular flow also illustrates the equality between the income earned from production and the value of goods and services produced. The circular flow diagram illustrates the interdependence of the “flows,” or activities, that occur in the economy, such as the production of goods and services (or the “output” of the economy) and the income generated from that production. These activities are represented by the blue lines in the diagram above. That income is spent on the goods and services businesses produce. Businesses provide individuals with income (in the form of compensation) in exchange for their labor. Īlternatively, one can think of these transactions in terms of the monetary flows that occur. These activities are represented by the green lines in the diagram. In its most basic form it considers a simple economy consisting solely of businesses and individuals, and can be represented in a so-called "circular flow diagram." In this simple economy, individuals provide the labour that enables businesses to produce goods and services. The circular flow of income is a concept for better understanding of the economy as a whole and for example the National Income and Product Accounts (NIPAs). Overview Model of the circular flow of income and expenditure Richard Stone further developed the concept for the United Nations (UN) and the Organisation for Economic Co-operation and Development to the system, which is now used internationally. Important developments of Quesnay's tableau were Karl Marx's reproduction schemes in the second volume of Capital: Critique of Political Economy, and John Maynard Keynes' General Theory of Employment, Interest and Money. François Quesnay developed and visualized this concept in the so-called Tableau économique. ![]() The idea of the circular flow was already present in the work of Richard Cantillon. The circular flow analysis is the basis of national accounts and hence of macroeconomics. The flows of money and goods exchanged in a closed circuit correspond in value, but run in the opposite direction. The circular flow of income or circular flow is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. The functioning of the free-market economic system is represented with firms and households and interaction back and forth. Basic diagram of the circular flow of income. ![]() Money flows in the opposite direction from goods and services. The flow of money is shown with purple, and the flow of goods and services is shown with orange. This graph shows the circular flow of income in a five-sector economy. Not to be confused with Circular economy.
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