Question

Take a portion of the Toppling Dominos story and explain it using the Circular Flow Diagram we learned in Chapter 2. Your answer must identify resource and product market, business, household and all of the appropriate terms representing flow of funds and resources.

Answer 1

Answer: The given diagram (shown below) shows the circular flow of money through the economy. This is used to represent that in an economy, the households and firms are interconnected. Both, households and firms are buyers and as well as sellers! The households buys goods and services from the firms in the product market, and in exchange pays money to the firms. The households are the owners of factors of production which it sells in the resource markets to the firms, and in exchange earns money as wage income.

The firms uses the money earned through the sell of goods of services to the households in the product market to buy factor of production from the households in resource/factor markets and produce more goods and services which it can sell. The households uses the money earned through the sell of factor services to the firms in the factor market to buy goods and services from the firms in product market.

The story of toppling dominoes represents the interdependence of each unit on each other (here: household, firms or the markets) which can be represented by the circular flow diagram for an economy. The households and the firms and the corresponding markets co-exist in an economy and cannot be independent. If households are the only unit in the economy then without the firms it won't be able to purchase goods and services and won't be able to earn by selling factor services to the firm, and hence, cannot exist alone. Similarly, the firms cannot exist alone in the economy!

In the above diagram, each box represents a dominoe where each of them is interdependent on each other. The outer arrow-loop represent the flow of goods and services while the inner arrow-loop represents the flow of money. The sign of arrows represent the flow of goods and services and money in the given direction. Each box is labelled and hence represents that particular unit.