Interpret a circular flow diagramExsimple the importance of financial theories and also modelsDescribe goods and also solutions markets and also labor markets
Figure 1.

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John Maynard Keynes. One of the the majority of influential financial experts in modern-day times was John Maynard Keynes. (Credit: Wikimedia Commons)

John Maynard Keynes (1883–1946), among the biggest economic experts of the twentieth century, mentioned that economics is not just a subject area but additionally a means of thinking. Keynes, displayed in Figure 1, famously wrote in the advent to a fellow economist’s book: “ is a technique rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions.” In other words, business economics teaches you just how to think, not what to think.

Watch this video around John Maynard Keynes and also his affect on economics.


Economists view the human being with a different lens than anthropologists, biologists, classicists, or practitioners of any kind of other discipline. They analyze worries and also problems with economic theories that are based upon specific assumptions around human habits, that are various than the assumptions an anthropologist or psychologist could use. A theory is a simplified representation of exactly how 2 or more variables interact via each other. The objective of a concept is to take a complex, real-civilization issue and also simplify it down to its essentials. If done well, this enables the analyst to understand the problem and any kind of troubles around it. A good theory is easy sufficient to be construed, while facility enough to capture the crucial attributes of the object or situation being stupassed away.

Sometimes financial experts usage the term model rather of concept. Strictly speaking, a theory is a more abstract depiction, while a model is more applied or empirical representation. Models are provided to test theories, yet for this course we will usage the terms interchangeably.

For instance, an architect that is planning a significant office structure will often develop a physical design that sits on a tablepeak to show exactly how the entire city block will look after the brand-new building is created. Companies often develop models of their brand-new products, which are even more turbulent and unfinished than the final product will be, but have the right to still demonstrate just how the brand-new product will certainly work-related.

A excellent design to start via in economics is the circular flow diagram, which is shown in Figure 2. It pictures the economic climate as consisting of two groups—households and also firms—that interact in two markets: the goods and solutions market in which firms market and family members buy and the labor market in which families offer labor to organization firms or other employees.

Figure 2. The Circular Flow Diagram. The circular circulation diagram shows how family members and also firms communicate in the products and also solutions industry, and in the labor sector. The direction of the arrows shows that in the goods and also solutions industry, families get goods and services and also pay firms for them. In the labor industry, households administer labor and also obtain payment from firms via wages, salaries, and also benefits.

Of course, in the real civilization, tbelow are many type of different industries for goods and also services and markets for many different kinds of labor. The circular circulation diagram simplifies this to make the picture simpler to grasp. In the diagram, firms produce goods and also solutions, which they market to family members in rerevolve for revenues. This is shown in the external circle, and also represents the two sides of the product market (for example, the market for products and also services) in which households demand also and also firms supply. Households sell their labor as workers to firms in rerotate for wperiods, salaries and benefits. This is shown in the inner circle and represents the two sides of the labor sector in which households supply and firms demand.

This version of the circular circulation version is stripped dvery own to the essentials, but it has sufficient attributes to describe exactly how the product and also labor sectors work in the economy. We might easily include details to this standard design if we wanted to introduce more real-people elements, choose financial sectors, federal governments, and interactions with the rest of the globe (imports and also exports).

Economists carry a collection of theories in their heads prefer a carpenter carries around a toolkit. When they view an financial worry or problem, they go via the theories they recognize to check out if they have the right to find one that fits. Then they usage the theory to derive insights about the problem or problem. In economics, theories are expressed as diagrams, graphs, or also as mathematical equations. (Do not concern. In this course, we will largely use graphs.) Economists execute not number out the answer to the trouble first and also then draw the graph to highlight. Rather, they usage the graph of the theory to aid them figure out the answer. Although at the introductory level, you deserve to occasionally number out the appropriate answer without using a design, if you store studying economics, before as well lengthy you will certainly run right into issues and difficulties that you will must graph to fix. Both micro and also macrobusiness economics are defined in regards to theories and models. The the majority of renowned theories are probably those of supply and also demand, however you will certainly learn a number of others.

Key Concepts and Summary

Economists analyze difficulties in a different way than execute other disciplinary experts. The primary devices financial experts usage are financial theories or models. A theory is not an illustration of the answer to a problem. Rather, a concept is a tool for determining the answer.

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Self-Check Questions

Suppose we extfinish the circular flow model to include imports and exports. Copy the circular flow diagram onto a sheet of paper and then include a foreign country as a 3rd agent. Draw a stormy sketch of the flows of imports, exports, and also the payments for each on your diagram.What is an example of a difficulty in the human being this day, not mentioned in the chapter, that has actually an economic dimension?

Rewatch Questions

How did John Maynard Keynes define economics?Are families generally buyers or sellers in the products and also services market? In the labor market?Are firms primarily buyers or sellers in the products and also services market? In the labor market?

Critical Thinking Questions

Why is it unfair or meaningless to slam a concept as “unrealistic?”Suppose, as an economist, you are asked to analyze an issue unfavor anything you have actually ever done prior to. Also, intend you perform not have a particular design for analyzing that worry. What must you do? Hint: What would a carpenter perform in a comparable situation?


circular circulation diagrama diagram that views the economic situation as consisting of family members and firms interacting in a items and solutions sector and also a labor marketgoods and solutions marketa market in which firms are sellers of what they create and households are buyerslabor marketthe market in which families offer their labor as workers to company firms or other employersmodelsee theorytheorya representation of an object or case that is simplified while including enough of the essential attributes to help us understand also the object or situation


Answers to Self-Check Questions

Draw a box external the original circular circulation to reexisting the foreign nation. Draw an arrow from the international country to firms, to represents imports. Draw an arrow in the reverse direction representing payments for imports. Draw an arrowhead from firms to the international nation to reexisting exports. Draw an arrow in the reverse direction to represent payments for imports.There are many kind of such problems. Consider the AIDS epidemic. Why are so few AIDS patients in Africa and also Southeast Asia treated with the same drugs that are reliable in the USA and also Europe? It is because neither those patients nor the countries in which they live have actually the sources to purchase the very same drugs.