In the circular flow diagram, how do households interact with firms in the factor market?

• A. Households demand goods and pay firms for products.
• B. Households supply labor and receive wages from firms.
• C. Households lend money to firms and receive interest payments.
• D. Households purchase capital from firms and earn profits.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the circular flow diagram, which illustrates the interactions between households and firms in two main markets: the product market and the factor market.
2. Step 2: Identify the role of households in the factor market. Households provide factors of production such as labor, land, and capital to firms.
3. Step 3: Recognize that in exchange for supplying these factors, households receive income from firms. For labor, this income is wages; for capital, it could be interest or profits.
4. Step 4: Specifically focus on labor as a factor of production. Households supply labor to firms, and firms pay wages to households in return.
5. Step 5: Conclude that in the factor market, the interaction is characterized by households supplying labor and firms paying wages, which matches the correct answer.