Money flow and real flow are the two main aspects of the circular flow of income economic model. Both refer to exchanges of goods and services for money, but the two concepts differ in how they refer to the opposite sides of these exchanges as they relate to individuals and companies.
Real flows refer to the flow of the actual goods or services, while money flows refer to the payments for the services (wages, for example) or consumption payments.
- Money flows depict the way that money and credit circulate in the economy as income turns into savings and investment and back again.
- Real flows depict the way that commodities and products & services are produced and consumed in the economy.
- While mainstream economists often discount the relation between real and money flows, many others understand that the two are intrinsically linked.
The Circular Flow of Income
In a modern exchange economy, one in which all economic exchanges involve money, the circular flow of income model attempts to depict the back and forth flows of money and services between individuals (or households) and companies. In explaining the flow of money, this economic model uses the terms “money flow” and “real flow” to designate the nature of the different exchanges that take place.
Within the model, individuals are considered to be both the possessors of factors of production (such as labor, services or property) and as consumers, the purchasers of goods. Companies are considered to be both the producers of goods and the purchasers of factors of production.
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Real Flows Versus Money Flows
Real flows include the factors of production, such as labor or land, that flow from individuals to companies, as well as the flow of goods and services from companies to individuals.
Meanwhile, money flows occur when companies pay wages in return for labor or services provided by individuals, as well as when individuals spend money to obtain goods or services produced by companies.
The Real Versus Money Economy
When mainstream economists speak of the economy, they are most likely referring to the “real” economy—that is, the production and consumption of actual goods and services. In this model, money is merely a “veil” that obscures the actual production economy underlying it, where money serves as a lubricant to make trade and transactions more efficient and less costly.
Other economists, however, such as those in the Keynesian and Monetarist traditions, believe that money and finance are real factors in the economy and cannot be ignored as a simple veil. Karl Marx, writing about capitalism in the 19th century, famously linked the real and money flow together using his conception of M – C – M’, where money is converted into commodities (M – C), which are then sold for a profit greater than the money put in (M’).
The 2008 financial crisis, which resulted in part from a lack of financial liquidity in credit and money markets, speaks to the importance of the money economy, especially in today’s global market.
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