A good model to start with in economics is the circular flow diagram, which is shown in Figure 1.6. It pictures the economy as consisting of two groups-households and firms -that interact in two markets: the goods and services market in which firms sell and households buy and the labor market in which households sell labor to business firms or other employees.

The Circular Flow Diagram The circular flow diagram shows how households and firms interact in the goods and services market, and in the labor market. The direction of the arrows shows that in the goods and services market, households receive goods and services and pay firms for them. In the labor market, households provide labor and receive payment from firms through wages, salaries, and benefits.

Goods and Services Wages, Households Salaries, and Benefits Firms Labor Services Payment for Goods and Services