Which of the following best describes the circular flow model?

• A. It depicts the process by which firms maximize profits through cost minimization.
• B. It shows the relationship between supply and demand in a single market.
• C. It illustrates how money, goods, and services flow between households and firms in an economy.
• D. It explains how government sets prices for goods and services.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the circular flow model as a fundamental concept in microeconomics that illustrates the continuous movement of money, goods, and services between different sectors of the economy.
2. Step 2: Identify the two main agents in the circular flow model: households and firms. Households provide factors of production (like labor) to firms, and in return, they receive income (wages, rent, etc.).
3. Step 3: Recognize that firms use the factors of production to produce goods and services, which they sell to households. This creates a flow of goods and services from firms to households.
4. Step 4: Note that money flows in the opposite direction: households spend money to buy goods and services from firms, and firms pay households for the factors of production. This creates a continuous loop of economic activity.
5. Step 5: Conclude that the circular flow model does not focus on profit maximization, supply and demand in a single market, or government price setting, but rather on illustrating the interdependence and flow of resources and money between households and firms.