According to the circular-flow model, which of the following best describes the flow of income and goods between households and firms?

• A. Households and firms both produce goods and services and exchange them directly without any flow of income.
• B. Only firms participate in the circular flow, while households are passive recipients of goods and services.
• C. Firms provide factors of production to households and receive income in return, while households produce goods and services that firms purchase.
• D. Households provide factors of production to firms and receive income in return, while firms produce goods and services that households purchase.

Answer: (D)

Verified step by step guidance

1. Understand the circular-flow model as a representation of how money, resources, and goods move between different sectors of the economy, primarily households and firms.
2. Identify the roles of households and firms: households own and provide factors of production (like labor, land, and capital), while firms use these factors to produce goods and services.
3. Recognize that in the factor market, households supply factors of production to firms, and in return, firms pay households income (wages, rent, interest, profits).
4. In the product market, firms produce goods and services which households purchase using the income they earned, completing the flow of goods and money.
5. Conclude that the circular flow involves households providing factors of production to firms and receiving income, and firms producing goods and services that households buy, illustrating the continuous exchange in the economy.