Question

1) Identify and explain using evidence from the lesson ONE reason that economists use theories and models.

2) Why is the Circular Flow Model a good model to start with in economics?

Answer 1

1. Economists use theories and models to understand the economy in simpler manner. They provide a general framework in which actual economic situations can be assessed and solutions be provided to any problems. For example: the Philips Curve theory gave us an understanding between inflation and unemployment. This was the first time tgat policy makers learnt that unemployment can be reduced at the cost of higher inflation.

2. The Circular Flow Model is a basic concept which explains the flow of money through the economy via various economic agents. It explains how value is created and money is transmitted in exchange of goods and services. For eg: if you own a land and rent it to a farmer for an amount x. Say the farmer produces corn and sells in the market. You go to the market and buy corn of the amount x. This amount goes back to the farmer. This is a very basic example of how money travels from factors of production (land) to producers via consumers.

It is good starting point for several economic models as they are based in the basic premise of money flow. National accounting traces money flow to obtain national income figures. Growth models like Harrod Domar use concept of flow of money to devise theories.

Thanks!