The circular flow diagram pictures the economy as 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 firms.
Firms produce and sell goods and services to households (arrow A). Households pay for those goods and services, and the payments become the firms' revenue (arrow B). Arrows A and B are the two sides of the goods and services market. Where do households get the income to pay? They provide the labor and other resources firms need (arrow C), and firms pay for them with wages, salaries and benefits (arrow D). Arrows C and D are the two sides of the labor market.
The direction of the arrows is the point: everything on the top half flows to households, everything on the bottom half flows to firms, and each group's spending is the other group's income.
| Arrow | Flow | Market |
|---|---|---|
| A | Goods and services, firms to households | Goods and services |
| B | Payment for goods and services, households to firms | Goods and services |
| C | Labor services, households to firms | Labor |
| D | Wages, salaries and benefits, firms to households | Labor |