The Modified Circular Flow Model is a visual representation of how goods, services, and money flow through an economy. In this model, there are two main markets: the product market and the factor market. The factor market is where the factors of production, such as land, labor, capital, and entrepreneurship, are bought and sold.
There are two main parties that participate in the factor market: households and businesses.
Households are the owners of the factors of production, and they supply these factors to businesses in exchange for payment. For example, households supply labor in exchange for wages, they supply land in exchange for rent, and they supply capital in exchange for interest or profits. In this way, households are sellers in the factor market.
Businesses, on the other hand, are the buyers in the factor market. They demand the factors of production to produce goods and services, which they then sell in the product market. Businesses pay for the factors of production through the revenues they earn from the product market. The payments made to households in exchange for the factors of production are considered costs of production for businesses.
In summary, households supply the factors of production in the factor market, and businesses demand these factors to produce goods and services in the product market. Through this exchange, households receive income from the factor market and businesses incur costs of production.