Business cycles

There are multiple model to describe the flow of income, production factos and goods/services in a economy. The simplest one is two-sector circular flow model.

Two sector circular flow model

It makes following assumptions:
1. Closed economy
2. No government

So, in such an economy,
1. Only two sectors are present in the economy, viz. households and firms.
2. Only two market are present in the economy, viz. goods/services market and production factor market
4. There are only two types of aggregate demand:
– Consumption (C) of goods and services by households
– Investment (I) of private firms

Flow of money:
Firms ---wages,rent, interest, dividend----(factor market)---income----> Households ---- consumer spending ----(goods and services market)-----revenue----> Firms

Reverse flow of factors and goods/services
Households ----land, labor, capital ----(factor market)----factors of production ---> Firms ----goods and services ----(goods and services market) ----> Households

Four sectors model

There are four sectors in the real economy, viz.
1. Households: Household sectors uses a part of their income for consumption and save the remaining.

2. Firms: Firms sectors makes investments for production and retained part of earnings 

3. Government: Government ensure that economy runs smoothly. Government makes expenditures, transfer and other interventions to ensure the growth of an economy.

4. Rest of the world:

Markets in the economy are

1. Labor market

2. Product market (goods & services)

3. Financial market

---------------------------------------------------------------------------------------------------------------------

Notes:
In the financial market, firms & people takes loan when expected rate of return is higher than the rate of interest on loan. In developed countries there are scenario where rate of return is so low that people do not take loans even at close to zero percent interest rate.

Government "transfers" the money in the form of subsidy etc to households.

Government "borrows" in the form of securities etc

GDP number quantifies the aggregate demand of an economy.

Aggregate demand = C + G + I + X = GDP

Rest of the world -> "balance of payment table" available on RBI website