Economic Agents and the Circular Flow of Income
Sofía's mom is a teacher at a public high school in Puebla. She gets her biweekly paycheck, pays VAT (IVA) at the neighborhood grocery store, and, with taxes like that one, the city repairs the street where she lives. They seem like three different things, but they are the same economic circuit making one full loop.
Economic Agents
Economics studies how societies meet their needs through the production, distribution, and consumption of goods and services. To describe who does what, people and organizations are grouped into three large categories.
In an open economy there is a fourth agent: the rest of the world (imports and exports). To understand the basic circuit of a neighborhood or a town, the first three are enough.
Name the three main economic agents and explain in one sentence what each one does. Give an example from your own life for each one (your family, a firm you know, a…
Name the three main economic agents and explain in one sentence what each one does. Give an example from your own life for each one (your family, a firm you know, a government service you use).
The Circular Flow of Income
Every exchange has two sides: something is handed over and something is paid. The circular flow is a model, that is, a simplification of reality, that diagrams those exchanges between agents.
Click each arrow in the diagram to see which flow it represents and between whom it moves.
Classify these flows into real (things or work that move) or monetary (money that moves): (a) the wage your mother earns; (b) the hours she works; (c) the sandwich you…
Classify these flows into real (things or work that move) or monetary (money that moves): (a) the wage your mother earns; (b) the hours she works; (c) the sandwich you buy in the cafeteria; (d) the $\$40$ you pay for it; (e) the taxes a shop pays; (f) the road built by the government.
The diagram shows the circular flow of income between households and firms, but one of the streams is covered with a question mark. a) The covered stream returns from…
The diagram shows the circular flow of income between households and firms, but one of the streams is covered with a question mark.
- a) The covered stream returns from firms to households carrying money: state what it is and where it comes from.
- b) Explain why we talk about a 'circular' flow: trace with your finger the full journey of $\$100$ from a worker's wage until it returns to a firm.
Sofía's mother is a teacher at a public middle school. Describe the full circuit: what flow she gives, what flow she receives, where the money for her wage comes from…
Sofía's mother is a teacher at a public middle school. Describe the full circuit: what flow she gives, what flow she receives, where the money for her wage comes from (follow the taxes), and what flows her family generates when spending it at the local supermarket.
The Government, Taxes, and Public Services
Your school is a state school: nobody pays to study there, but it is not free. Explain who finances it, through which flows (where the money comes from and where it…
Your school is a state school: nobody pays to study there, but it is not free. Explain who finances it, through which flows (where the money comes from and where it goes), and name two more public services that you use or will use, indicating the tax that supports them.
Leakages, Injections, and Chain Effects
Not all of a household's income returns to the circuit right away as purchases. Part of it leaves everyday spending, and another part enters from outside household consumption.
Saving is not "bad": when it is deposited in a bank, the bank lends it to businesses or households, and that loan can become investment. The problem appears when the money just stays put and does not return to the circuit.
Suddenly, all the households in a neighbourhood decide to save half of what they used to spend on leisure (cinemas, cafés, hairdressers). Explain what happens to local…
Suddenly, all the households in a neighbourhood decide to save half of what they used to spend on leisure (cinemas, cafés, hairdressers). Explain what happens to local firms in the circular flow, what they might end up doing with wages, and why saving that is good for an individual household can cool down the neighbourhood's economy if everyone does it at the same time.
The furniture factory in a town, employing $80$ workers, closes down. Trace the chain effects on the town's circular flow: what households stop receiving, what they stop…
The furniture factory in a town, employing $80$ workers, closes down. Trace the chain effects on the town's circular flow: what households stop receiving, what they stop buying in stores, what happens to those stores as a result, and how much less tax the municipality collects. Why is it said that the effects multiply?
In the circuit there are 'withdrawals' (money leaving current spending: savings, taxes) and 'injections' (money coming in: public spending, business investment).…
In the circuit there are 'withdrawals' (money leaving current spending: savings, taxes) and 'injections' (money coming in: public spending, business investment). Classify each example as a withdrawal or an injection and explain its effect: (a) a household saves $\$4\,000$ per month; (b) the municipality builds a sports center; (c) a bakery buys a new oven; (d) taxes go up.
At the high school entrepreneurship fair, the AMPA acts as the public sector and a financial institution: it lends $\$40$ to each of the $10…
At the high school entrepreneurship fair, the AMPA acts as the public sector and a financial institution: it lends $\$40$ to each of the $10$ projects and establishes a $5\ \%$ "tax" on sales for the end-of-year trip fund. Halfway through the day, sales freeze: visiting students have spent all their allowance at the first few stalls, and the other teams are accumulating unsold products, fearing they will not be able to repay the loan.
- a) Use the circular flow model to diagnose the problem: identify precisely which flow (monetary or real) and in which market the bottleneck has occurred, and explain what consequences it will have for the AMPA fund.
- b) Design two alternative measures to restore the circular flow (one acting on student demand and the other from the school cooperatives or the AMPA) and justify which of them would better prevent project indebtedness.
Back to the beginning: Sofía's mom (a household) gets her biweekly paycheck from the public school (the government), buys at the grocery store (a business) and pays VAT (IVA), and the city uses taxes like that one to repair her street. The three agents are joined in one single circuit.