Question

1. The economy's income and expenditure

The following diagram presents a circular-flow model of a simple economy. The outer set of arrows (shown in green) shows the flow of dollars, and the inner set of arrows (shown in red) shows the corresponding flow of inputs and outputs.

Markets for Goods and Services Firms Households Markets for Factors of Production

Based on this model, households earn income when (firms) or households) purchase (goods and services) or (labor and capital) in markets for factors of production.

Suppose Neha earns $800 per week working as a doctor for the Medical Clinic. She uses $9 to buy a box of aspirin at Pillmart Pharmacy. Pillmart Pharmacy pays Lorenzo $300 per week to work the cash register. Lorenzo uses $125 to purchase medical services from the Medical Clinic.

Identify whether each of the following events in this scenario occurs in the market for factors of production or the market for goods and services.

Which of the elements of this scenario represent a flow from a firm to a household? This could be a flow of dollars, inputs, or outputs. Check all that apply.

( ) The aspirin Neha receives

( ) The $125 Lorenzo spends to purchase medical services from the Medical Clinic

( ) The $300 per week Lorenzo earns working for Pillmart Pharmacy

True or False: Gross domestic product (GDP) cannot be used to measure the economy's income.

True

False

Answer 1

We see that households earn income when firms purchase labor and capital in markets for factors of production. This is the factor income earned by households in exchange for their services.

Lorenzo spends $125 in buying medical services. This is done in the market for goods and services because a service is purchased.

Lorenzo is earning a factor income of $300 per week. This is done in the market for factors of production because factor services are sold for income

Neha spends $9 in purchase of a box of aspirin. This is done in the market for goods and services because a product is purchased.

A flow from firm to households include the flow of monetary income as factor income and a flow of goods and services sold to them in exchange for money. This includes box of aspirin Neha receives and a factor income of $300 per week received by Lorenzo.

False. GDP is used to measure the total spending or total income of the economy.