According to the circular flow diagram, how do households earn income?

• A. By saving money in financial institutions
• B. By selling factors of production, such as labor, to firms in factor markets
• C. By paying taxes to the government
• D. By purchasing goods and services from firms in product markets

Answer: (B)

Verified step by step guidance

1. Understand the circular flow diagram, which illustrates how money, resources, and goods move between different sectors of the economy, primarily households and firms.
2. Identify the role of households in the circular flow: households provide factors of production (such as labor, land, and capital) to firms through factor markets.
3. Recognize that households earn income by selling these factors of production to firms. For example, when a household member works for a firm, they receive wages as income.
4. Note that saving money in financial institutions, paying taxes, or purchasing goods and services are activities households do with their income, but these are not how they earn income.
5. Conclude that the correct way households earn income in the circular flow diagram is by selling factors of production, such as labor, to firms in factor markets.