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CIRCULAR FLOW OF ECONOMIC ACTIVITY

The basic tenet of the circular flow of economic activity is, "What goes around comes around." The circular flow begins with the spending habits of consumers. How much and how fast consumers spend then drives the amount of investments that businesses make in resources to produce goods. These investments in turn affect the number of jobs that are available and the general economic health of a region. As more jobs become available, consumers have more money to spend. Conversely, as employment levels drop, consumers have less money to spend on goods and services. Consumer spending also determines the kinds and quantities of products that businesses produce.

The circular flow theory was first advanced by the physiocrats, a school of economics in the 1700s. The major proponent of the physiocratic view, Francois Quesnay (1694–1774), wrote in 1758 that the circular flow was a natural order in economics and self-sustaining. Quesnay proposed that the flow had an inherent self-correcting mechanism and therefore did not need to be directed by government. The circular flow created a balance by automatically decreasing and increasing consumer spending levels and business investments when needed.

See also: Business Cycle