Unit 6: Models of Business and Economic

Activities
Lesson 6.1
The Circular Flow of Economic Activity

Contents
Introduction 1

Learning Objectives 2

Let’s Connect 2

Discover 4
Circular Flow of Economic Activities 4
Markets and the Circular Flow 5
Government and the Circular Flow 7

Wrap-Up 8

Try This! 9

Challenge Yourself 10

Photo Credit 11

Bibliography 11
Unit 6: Models of Business and Economic

Lesson 6.1

The Circular Flow of Economic

Activity

Introduction
Have you ever wondered how di fferent goods and services reach your household? For example,
how do your favorite breakfast cereals become available for you to enjoy every morning? Who
made those cereals and how were they made? Those breakfast cereals are produced by a company
that employs people and uses raw materials and equipment to ensure that those products are
readily available for our consumption.

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Unit 6: Models of Business and Economic

The simple circular flow of economic activities is composed of three sectors: household,
businesses, and the government. We will look at the flow of goods and services from business to
household, the flow of factors from household to businesses, and the role of the government and
the foreign sectors in the economy. The flow of payments in exchange for products and the factors
that affect it will also be discussed. We will emphasize the ability to identify opportunities in the
economy as a necessary skill to learn in order to keep your business competitive.

Learning Objectives DepEd Learning Competency

At the end of this lesson, you should be able to
In this lesson, you should be able to do the analyze how the flow of activities in households and
following: businesses affects the entire economy (Additional
competency for enrichment).
● Analyze how the flow of activities in
households and business sectors
affects the economy.
● Conduct a survey of macro and
micro environments affecting
business in a locality.

Let’s Connect
10 minutes
Household and Business Exchange
Households buy goods and services from businesses. Businesses, on the other hand, get
the needed factors for production from households. For this activity, students will work in pairs. One
will represent households and the other will represent businesses.

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Instructions
1. The student that represents the household will identify three goods and two services that they
buy from different businesses.
2. The student that represents the business will now identify the five different
companies or corporations that will provide those products.
3. Together, identify the prices of those goods and services. Use their average prices.
4. Still working together, identify the input or raw materials needed to produce those goods
or services.

Guide Questions
1. Why do businesses charge consumers that price?

2. How do households contribute to the production of goods and services offered by the
different businesses?

3. How do households get income from businesses?

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Unit 6: Models of Business and Economic
Discover

The diagram below on the circular flow of economic activities shows how resources, income, and
goods and services flow in the economy through the interaction of the di fferent economic
players. The interrelationship of households and businesses causes basic economic activities to
occur. Basic economic activities such as production, consumption, employment, and income
generation happen because of the presence of the two sectors. The firm produces goods, services,
and employment, while the household consumes these goods and services. Households generate
income since they own the factors needed for production.

How will the flow of activities between households and

businesses affect the entire economy?

Circular Flow of Economic Activities

Fig. 1. The flow of resources, income, and goods and services among the sectors

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Unit 6: Models of Business and Economic
There are three key players or sectors that comprise a very simple economy: the household sector,
business sector, and the government sector.

The household sector is the consuming unit. It owns the resources or factors of production: land,
labor, capital, and entrepreneurship needed by the business. In economics, the land is defined to
encompass all the resources above and beneath the ground (water, trees, etc. are part of the land).
Labor is the human resource, while capital includes equipment, factories, and machinery.
Entrepreneurship is the managerial skill needed to properly utilize the three other factors. Those
factors are used to produce goods and services by the business sector. The goods and services
produced by the business are used by the households for their everyday needs and wants.

The business sector (firms) is the basic producing unit. Firms exist when a person or group of
people come together to transform input or factors of production owned by the households into
output or goods and services that are sold in the market. Most firms are established to make a profit;
that is, they can sell their product at a price higher than what it costs to produce.

The government acts as a regulating unit. It collects money in the form of taxes from households
and firms. In return, the government produces public goods, such as roads and other infrastructures
for economic viability, as well as finances social services, such as education, health, and public
safety, among others. Part of the taxes collected by the government is also subsidized to the
marginalized groups, such as farmers and the elderly.

Markets and the Circular Flow

There are two basic kinds of markets households and firms engage in. These are the input (factor) and
the output (product) markets.

The production of goods and services requires input or resources. These resources are also called the
factors of production. The household, being the owner of the factors, o ffers and/or supplies these
resources (land, labor, capital, and entrepreneurship) for sale to firms through the input or
factor markets. In return, firms offer factor payments to the

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Unit 6: Models of Business and Economic
households. Factor payments include rent for land, wage or salary for labor, interest for
capital, and profit for entrepreneurship.

The resources that firms buy from households are transformed into goods and services. These
products are exchanged in the output or product markets. The income that households earn
from the sale of the resources is used to consume goods and services.

Consumption expenditure is the term used to encompass all the purchases of the household.
The household is considered the basic consuming unit in a circular flow of the economy. The
household expenditures will become the revenue of the business that they will use to pay for the
factors of production.

Figure 1 illustrates the circular flow of economic activity. Note that resources (and products) flow
counterclockwise, indicated in blue: resources flow from households to firms, and products flow
from firms to households. On the other hand, money or payment flows clockwise, indicated in red:
payments for input flow from firms to households, and payments for the consumption of goods and
services flow from households to firms.

Check Your Progress

How does the business sector pay for the factors of productions they use to
produce goods and services?

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Government and the Circular Flow

Government plays a critical role in any economy. The government acts as a regulating agency
that binds the households and businesses to ensure that fair and equitable trade is achieved. To
ensure that the government can carry out its mandates, it has to collect a sum of money from both
the households and firms through taxes, fines, and dues, among others. In return, the government
provides them with the mechanisms with which they can carry out their roles in the economy. The
government produces public goods, such as roads, bridges, and other infrastructures for economic
viability. In addition, the government finances social services, such as education, health, and public
safety, among others.

Figure 1 shows the relationship of the government with households and businesses. It is
positioned at the center to emphasize that it acts to regulate and maintain order in the economy.

Check Your Progress

How does the household sector afford the goods and services they buy from
the business sectors?

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In Philippine Context
The 2020 Gross Domestic Product projections made by International Monetary Fund and World
Bank shows that the remittance inflow in the Philippines will decrease by 14-20% and the
household spending will decline by 1-2% (food expenditure per capita by 2-3%) in one year as
a result of the COVID-19 pandemic.

This may be attributed due to the slowing down of economic activities around the globe. Many
establishments and firms of all sorts have gone out of business. Many workers were displaced,
forced to accept lower wages, or laid off due to lockdowns. As a result, they were not able to
send remittances to their families.

Domestically, the stringent movement restrictions and lockdowns adversely impacted the business
sector as they were forced to lay off many of their workers. This, in turn, lowered household
spending, which is a key economic driver for the country.

Wrap-Up
_____________________________________________________________________________________________
● The interrelationship between households and businesses shows the flow of goods
and services and the flow of income between the two sectors.
● The household is considered the basic consuming unit in a circular flow of the
economy.
● The government acts as a regulating agency that binds the households and
businesses to ensure that fair and equitable trade is achieved.
_____________________________________________________________________________________________

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Unit 6: Models of Business and Economic

Try This!
A. Identification. Write the correct answer in the provided space.

1. Basic consuming unit

2. Basic producing unit
3. Payment for household purchases
4. Regulating unit
5. The market where input is exchanged
6. The market where products are traded
7. The payments made by firms to households
8. The purchases made by households.
9. The sum that the government collects to finance public goods and
services.
10. A factor of production that means human resources

B. Matching type. Match column A with column B.

Column A Column B

1. land A. profit
2. labor B. interest
3. capital C. rent
4. entrepreneurship D. taxes and fees
5. public goods and services E. wage

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Unit 6: Models of Business and Economic

Challenge Yourself

List down two items in each factor of production needed to produce textiles.

1. Land

2. Labor

3. Capital

4. Entrepreneurship

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Unit 6: Models of Business and Economic

Suggested Rubric for Grading

The rubric below is a suggested one. Your teacher may modify the rubrics based on your needs.
Consult your teacher for the final rubric.

Performance Levels
Suggested
Criteria 1 2 3 Score
Weight
Beginning Proficient Advanced
Proficiency Proficiency
Did not provide an Provided a partially Gave the correct
Correct answer or provided a correct answer.
answer.
×3
wrong answer.
Answer

Presentation was made Presentation was done Presentation was done

Logical with serious errors with minor errors and without errors.
and inconsistencies. inconsistencies. ×3
Presentation

Total Possible Score 18

Photo Credit
Walmart Customer Selects a Fabric Reintroduced to Product Mix by Walmart Corporate is licensed
under CC by 2.0 via Flickr.
Bibliography
Mankiw, N. Gregory .2014. Principles of Economics. 7th Edition. Microeconomics. Ohio, USA:
SouthWestern Cengage Learning.

Murakami, Enerelt, Shimizutani, Satoshi and Yamada Eiji, “Projection of the E ffects of the
COVID-19 on the Welfare of Remittance-Dependent Households in the Philippines”.
Economics of Disasters and Climate Change (2020):1-14, https://doi.org/10.1007/s41885-
020-00078-9.

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