The Concept of

Equilibrium
EQUILIBRIUM – or Economic equilibrium
is a condition or state in which economic
forces are balanced. Economic equilibrium is
also referred to as market equilibrium.
The economy will be in equilibrium if the amount received by
firms from households is equal to the amount received by
households from the firms. Disequilibrium happens when
either households or firms do not spend all their incomes.

o FIRMS – are the business organization such as a

corporations, limited liability company (LLC), or partnership
that sells goods or services to make a profit.
o HOUSEHOLDS – is a social unit comprised of those living
together in same dwelling. They are usually the workers and
the consumers.
 The Effect of Savings and Investments

SAVING – is the amount of something that is not spent

or used.
People save for one reason or another. Among
the reasons are as follows:
1. to provide for old age
2. to provide for children’s education
3. to accumulate funds for acquisition of capital
goods
4. to accumulate wealth
INVESTMENT – is the purchase of goods that are not
consumed today but are not used in the future to
create wealth or refer to any mechanism used for
generating future income.
THE CIRCULAR FLOW OF INCOME BETWEEN
HOUSEHOLDS AND FIRMS
INCOME FLOW
(wages, interests, rents)

HOUSEHOLDS FIRMS

INCOME FLOW
(purchase of goods and services)
THE CIRCULAR FLOW OF INCOME BETWEEN
FIRMS
RAW MATERIALS INTERMEDIATE
Income flow
FIRMS GOODS FIRMS
for purchase
of raw materials

Income flow
for purchase of
intermediate goods

FINAL GOODS
FIRMS
Income flow
for purchase of
HOUSEHOLDS
final goods
THE EFFECT OF REDUCTION OF PURCHASES

REDUCED INCOME
(as a result of
reduced purchases
of economic resources)

HOUSEHOLDS FIRMS

REDUCED INCOME
(as a result of
purchases of goods
and services)
THE CIRCULAR FLOW OF GOODS AND INCOME IN A SIMPLE ECONOMY WITH SAVINGS
& INVESTMENT

investments
FIRMS
capital goods

rent, wages, land goods

interest, profit labor and
capital services payments

HOUSEHOLDS
savings
THE CIRCULAR FLOW OF GOODS AND INCOME OF
HOUSEHOLDS AND FIRMS WITH THE GOVERNMENT
AND FOREIGN COUNTRIES
 GOVERNMENT

V
land, labor, capital
rent, wages, interest payments for goods & services
rent, wages,
interest

HOUSEHOLDS FIRMS
goods &
services
payments payments
for imports for exports
payments for goods & services
FOREIGN
COUNTRIES
 SUMMARY
Firms produce goods and services by using the economic resources
of land, labor, and capital which are provided by households. When goods
and services are delivered to households for consumption, payments are
remitted to the firms. Money payments are also received by the
households when the economic resources they own are used by firms. The
payments made by one party becomes the income of the other party. The
exchange of resources, goods and services, and payments follow a circular
pattern.
The circular flow covers the production process, exchanges of
commodities, income between households and firms and between firms,
and exchanges between firms, households, the government, and the
foreign countries.