Question

1. Choose one of the following economic models to write about: Circular Flow Diagram, Budget constraint, or Production Possibility Frontier; 2. Define in your own words the model. How does the model work? What are the components of the model? What is the interaction among the components of the model? Provide examples to support your answers here; 3. Provide an example from your own life experience where you've had to use one of these 3 models to make a decision.

Answer 1

1. Circular Flow Diagram

2. The circular flow diagram shows the flow of goods, services and money between the sectors of the economy. For instance, if we take the 2 sector model there is household and firms. Household provides labour services, land, entrepreneurship to the firms who in return pay them salary/wages, profit or rent. This salary or wage is used to purchase the goods made by the firms. Therefore in the product market, the households buy and firms sell whereas in factor markets the households sell and firms buy. If we include the financial market as a sector then households put their saving into the financial market(bond, stocks, fixed deposit) which is further on given as investment( for expansion, purchase of capital)to firms. The firms pay interest to the banks and then interest is paid to households.

3. As students, we all are faced with a budget crunch as receive money for monthly expenditure hence inducing a budget constrain. While going grocery shopping I always have to think about what I really need and not what I want, the cost, and the total amount spent. As if I spend more than the equilibrium amount then it will reduce my expenditure on something else.