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Chapter 02 Homework-The circular-flow model

Chapter 02 Homework- EC110-Principles of Macroeconomics

2. The circular-flow model

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.

Chapter 02 Homework-The circular-flow model

Based on this model, households earn income when firms  Correct purchase factors Correct in factor markets.

Explanation:

In the circular-flow model of an economy, households own all the factors of production. Households earn their income when firms purchase or rent these factors of production to use them to produce goods and services. Firms, in turn, earn revenue when households buy goods and services.

Suppose Caroline earns $600 per week working as an interior designer for Ourhouse. She uses $9 to take a yoga class at Big Bend. Big Bend pays Antonio $450 per week to instruct yoga. Antonio uses $175 to purchase furniture from Ourhouse.

Identify whether each of the following events in this scenario occurs in the factor market or the product market.

EventFactor MarketProduct Market
Caroline spends $9 to take a yoga class.Correct
Antonio spends $175 to purchase furniture from Ourhouse.Correct
Antonio earns $450 per week working for Big Bend.Correct

Explanation:

In this scenario, households sell factors of production in factor markets when Caroline supplies her labor to Ourhouse and when Antonio supplies his labor to Big Bend. Moreover, a firm sells goods and services to a household in product markets when Big Bend provides the yoga class to Caroline and Ourhouse provides the furniture to Antonio.

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

Incorrect a.The yoga class Caroline receives

Incorrect b. The $450 per week Antonio earns working for Big Bend

Correct c. The $175 Antonio spends to purchase furniture from Ourhouse

Correct d. Caroline’s labor

Explanation

When Caroline (a household) supplies her labor to any firm, labor is an input (a factor of production) that flows from a household to a firm.

When the yoga class is provided to Caroline (a household), the yoga class is an output that flows from a firm to a household.

Big Bend (a firm) pays Antonio (a household) $450 for his labor. Therefore, the $450 is a payment that flows from a firm to a household.

Antonio (a household) pays Ourhouse (a firm) $175 for furniture. Therefore, the $175 is a payment that flows from a household to a firm.

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