Principles of Microeconomics / Unit 1 MIC 0011 worked example, 60 to 90 seconds
Which Market Is It?
The idea
To place a transaction in the circular flow, ask two questions. First, what is being bought: a finished good or service, or a factor of production such as labor, capital or land? A finished good runs through the product market; a factor runs through the factor market. Second, which way does money go? In the product market it flows from households to firms; in the factor market it flows from firms to households as wages, rent, interest and profit. Goods and factors move opposite to the money.
In practice
Worked example: a nurse earns four thousand dollars a month from a clinic. Labor is the thing bought, so it is a factor-market transaction: the labor flows to the firm and the wage flows to the household. The same nurse pays ninety dollars for a haircut. A service is the thing bought, so it is a product-market transaction: the service flows to the household and the money flows to the firm. A retiree who lends savings to a firm and receives interest is in the factor market, supplying capital.
Where people slip
Two traps. A payment between two firms, a bakery buying flour from a mill, stays inside the firm sector and never appears in the diagram. And rent can sit in either market: a family renting an apartment buys housing services in the product market; a landowner leasing land to a farm supplies a factor.
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