What Is Circular Flow Diagram

A circular flow diagram graphically represents the flow of money in society. We use it to create a framework to understand the economy better. Here, you will learn everything things about circular flow diagrams. Learn how to create a circular flow model and its uses. Also, check out our free circular flow diagram templates.

1. What is Circular Flow Diagram?

A circular flow diagram illustrates how money moves in a circular motion and creates an economy. In society, money flows from consumers to producers and flows back from producers to consumers in a circle through lots of complex processes. To explain this complex flow of money, we use simple and easy-to-understand circular flow diagrams. There are two main elements of a circular flow, the household, also known as the consumers, and the firms, also known as the producers.

The circular flow model depicts how the firms make money by selling produced goods and services. The firm then gives the money to their employees and workers in wages. The workers who receive the wages are also the consumers who use that money to buy those products or services. The money moves through society in an endless circular flow. The analysis we get from the circular flow diagrams provides the basis for national accounts. We use it to visualize the organization of the economy using a simple method. These are the four most commonly used types of the circular flow model.

Types of Circular Flow Models
  • Two Sector Model
  • Three Sector Model
  • Four Sector Model
  • Five Sector Model

Here is an example of a circular flow diagram depicting participants in a four-sector model.

What is Circular Flow Diagram

Click on the image to edit. Source: EdrawMax Online

2. What is Circular Flow Diagram in Economics?

The circular flow diagram is mainly used in economics to describe how the economy functions and the interactions involved between its various activities and aspects. It shows the economy as two opposite cycles where one cycle represents the goods from firms to individuals and the other cycle represents the opposite. Both of these cycles are essential for an economy to work properly because without wages, consumers can't buy products, and firms can't get an income without selling products. The circular flow diagrameconomics also depicts all the actors and activities involved in an economy.

3. Benefits of Circular Flow Diagram

Generate a market network with circular flow diagrams. We use these diagrams to describe the relationship between consumers and producers. The producers buy raw materials to develop services and goods with money, and consumers use the money to buy those goods. It creates a market network for various sales and purchases.

Improve trade policies by conducting analysis using a circular flow model. Leakages in the circular flow of money affect the economy of a country. The main reason for leakages is import where the money goes to foreign countries for their products. A circular flow analysis promotes export to improve the economy with better trade policies.

Monitor the inflation and deflation in the economy with a circular flow diagram. Economists use these diagrams to promote monetary policy and bring equality between savings and investments. All of this goes through the capital market that monitors equality. It points to the importance of monetary policy when either the savings or investments exceed each other.

4. When to Use Circular Flow Diagram

Injection and Leakage:We use circular flow diagrams to monitor the injections and leakages in the economy. Injection means adding more income in the circular flow of money in the form of investments or export. Leakages mean money withdrawal from the flow in savings and imports. The circular flow monitors the equality between both.

National Income Measurement: A circular flow diagram provides the estimate of the gross domestic product of any country. The estimate is done through many methods. Some of these methods only include sales and purchases with money, and some also include barter trade. The circular flow model better understands the economy or national income.

Nature of Economic Activities: The circular flow model graphically represents the nature of economic activities as a chain of unending productions, income, and expenditure. It explains how economic activities never stop their circular motion because a smooth flow of money depends on the equality between injection and leakage in the economy.

5. How to Create a Circular Flow Diagram?

Before creating a circular flow diagram, it is better to understand its main components. There are four main components in a circular flow that explain money flow in an economy. Consumers, Producers, services, and goods market, and factors of production market. Include these components in the circular flow and follow these steps to create your diagram quickly.

  • STEP 1: Describe the scope of your diagrams and brainstorm all the involved activities to understand the circular flow and its components better.
  • STEP 2: Determine the components of your diagram. You also have to select the types of circular flow diagrams you want to make in this step.
  • STEP 3: Draw symbols to illustrate the components and activities of your circular flow diagram. Make sure to use correct and distinct symbols to represent different activities.
  • STEP 4: Connect the activities and components with lines and other connectors to indicate the circular flow.

After understanding the guidelines to create a circular flow, it is time to get started with free templates and drawing software. EdrawMax Online is the best circular flow diagram maker that gives you free templates and many unique diagramming tools. It makes the process of creating a circular flow model easy for you by helping you save time and effort. Here are the steps to create your diagram on EdrawMax Online.

  • STEP 1: Log in to EdrawMax Online or create a new account.
  • STEP 2: You can make your diagram using a template or open a blank canvas to draw it from scratch. Go to new, and click on the basic diagram category. Select circular diagram and click on the "+" button to get a new canvas, or select a template to edit it right away.
  • STEP 3: The next step is to customize your circular flow diagram. Go to the symbols library and insert icons and symbols with a simple drag and drop. Add connecters to visualize the relationship between components.
  • STEP 4: After your diagram is complete, the next step is to download it. EdrawMax Online supports various document formats, so you can export in any format you want. You can also share and print it.

6. Free Circular Flow Diagram Templates

There are two methods to create a circular flow diagram. The first methods are to make your diagram from scratch, which is hard and takes time, and the second method is to use free templates. Using templates saves your time and effort by giving you a complete diagram that you can edit to use in your project. Here are our free circular flow diagram templates.

Example 1: Government Circular Flow Diagram

The government circular flow diagram in this template illustrates a 3-sector economy model. These models introduce government in the circular flow. The government is at the center, and the other four components are directly linked to it. The diagram describes how the government acts as the middle party and deals with the four components individually on its own instead of letting them directly deal with each other. Uses this template to estimate the GDP.

Government Circular Flow Diagram

Example 2: Economic Circular Flow Diagram

This template's economic circular flow diagram represents a four-sector economy model for income. The four-sector model introduces external sources such as the import and export of products or services. The diagram describes the circular flow of economic activity by creating a simple model with all main components involved in the economy. Economists commonly use this diagram to analyze government purchase of goods and services and borrowing stock issues by firms.

Economic Circular Flow Diagram

Example 3: Circular Money Flow Diagram

The circular money flow diagram in this template graphically represents the interrelation between various components of a circular flow. It showcases the flow of money in a circular motion. It tells you how the economy works. The firms sell their products and services for money to the consumer. The consumer also works for the firms and takes wages.

Circular Money Flow Diagram

7. FAQ About Circular Flow Diagram

1.What are 4 main parts of the circular flow diagram?

The market to overview the production factor. The four primary parts of the circular flow diagram are the consumers who purchase goods and services from firms. The producers sell their goods and give wages to their workers. The market for services and goods creates a link between the consumers and the producers.

2.What is a circular flow diagram in business?

The circular flow diagram in business illustrates the flow of money in an infinite loop as it moves from households to producers and from producers to households. The business gives money to consumers in the form of wages, and the consumers give money to the business after purchasing their goods or services. This process constructs the economy.

3.What is the 5-sector circular flow model?

The 5-sector circular flow model consists of five sectors. The three and four sector model introduces government and foreign sector. The five-sector model introduces the financial sector as a part of the circular flow of money. It showcases the interrelation of banks and non-bank intermediaries with the economy.

8. Key Takeaways

A circular flow diagram showcases money flow in a non-ending circular loop that creates a nation's economy. We use these diagrams to improve our monetary and trade policies, monitor the leakage and injections in the income, and better understand economic activities. EdrawMax Online is the best circular flow diagram maker. It gives free professional templates and a symbol library with various icons and symbols that you can use to create more than 280 types of diagrams. Go to EdrawMax and get started right away. You can easily create a circular flow diagram on EdrawMax Online. It gives you free professional templates and a symbol library to make your diagram. It also comes with unique customization tools and supports various document formats. Find more circular flow diagram examples.

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