factor market.

Of course, in the real world, there are many different markets for goods and services and markets for many

different types of labor. The circular flow diagram simplifies this to make the picture easier to grasp. In the

diagram, firms produce goods and services, which they sell to households in return for revenues. The outer

circle shows this, and represents the two sides of the product market (for example, the market for goods and
18 1 • Welcome to Economics!

services) in which households demand and firms supply. Households sell their labor as workers to firms in

return for wages, salaries, and benefits. The inner circle shows this and represents the two sides of the labor

market in which households supply and firms demand.

This version of the circular flow model is stripped down to the essentials, but it has enough features to explain

how the product and labor markets work in the economy. We could easily add details to this basic model if we
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