Interpret a circular flow diagramExsimple the prestige of financial theories and modelsDescribe products and solutions industries and labor markets
Figure 1.

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John Maynard Keynes. One of the a lot of prominent economic experts in modern-day times was John Maynard Keynes. (Credit: Wikimedia Commons)

John Maynard Keynes (1883–1946), among the greatest financial experts of the twentieth century, mentioned that business economics is not simply a subject area but also a method of reasoning. Keynes, presented in Figure 1, famously created in the development to a fellow economist’s book: “ is a method quite than a doctrine, an apparatus of the mind, a method of thinking, which helps its possessor to draw correct conclusions.” In various other words, business economics teaches you exactly how to think, not what to think.

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


Economists see the human being with a various lens than anthropologists, biologists, classicists, or practitioners of any type of various other self-control. They analyze concerns and problems via economic theories that are based upon particular assumptions around human habits, that are various than the presumptions an anthropologist or psychologist can usage. A theory is a streamlined representation of just how 2 or more variables communicate via each various other. The function of a concept is to take a complex, real-world worry and simplify it down to its essentials. If done well, this permits the analyst to understand also the issue and also any troubles about it. A good theory is basic enough to be interpreted, while facility enough to capture the vital features of the object or instance being stupassed away.

Sometimes financial experts use the term model instead of theory. Strictly speaking, a theory is a much more abstract representation, while a model is more used or empirical representation. Models are offered to test theories, however for this course we will certainly usage the terms interchangeably.

For example, an architect who is planning a significant office building will regularly build a physical model that sits on a tableheight to display just how the whole city block will look after the brand-new building is built. Companies frequently develop models of their brand-new products, which are even more rough and also unfinished than the last product will be, but deserve to still show exactly how the new product will job-related.

A excellent design to start via in economics is the circular flow diagram, which is displayed in Figure 2. It photos the economy as consisting of 2 groups—families and firms—that communicate in two markets: the products and also services market in which firms offer and families buy and also the labor market in which family members market labor to organization firms or other employees.

Figure 2. The Circular Flow Diagram. The circular circulation diagram reflects exactly how households and firms communicate in the goods and solutions industry, and also in the labor sector. The direction of the arrows shows that in the items and services sector, families obtain products and solutions and also pay firms for them. In the labor market, households provide labor and also receive payment from firms with weras, salaries, and benefits.

Of course, in the actual civilization, there are many type of different industries for goods and also solutions and markets for many kind of different forms of labor. The circular flow diagram simplifies this to make the image simpler to master. In the diagram, firms create goods and also services, which they sell to households in return for earnings. This is displayed in the outer circle, and represents the two sides of the product sector (for example, the sector for goods and also services) in which family members demand also and firms supply. Households offer their labor as workers to firms in rerevolve for wages, salaries and also benefits. This is shown in the inner circle and also represents the 2 sides of the labor industry in which family members supply and also firms demand also.

This version of the circular flow model is stripped down to the essentials, yet it has actually sufficient attributes to define exactly how the product and labor markets work in the economic situation. We could quickly include details to this standard design if we wanted to present even more real-human being facets, prefer financial industries, federal governments, and interactions through the rest of the world (imports and also exports).

Economists lug a set of theories in their heads like a carpenter carries roughly a toolkit. When they see an economic worry or difficulty, they go with the theories they understand to view if they have the right to discover one that fits. Then they usage the concept to derive insights about the concern or trouble. In business economics, theories are expressed as diagrams, graphs, or also as mathematical equations. (Do not problem. In this course, we will certainly mostly use graphs.) Economists carry out not number out the answer to the difficulty first and also then attract the graph to illustrate. Rather, they usage the graph of the concept to assist them figure out the answer. Although at the introductory level, you have the right to occasionally number out the best answer without using a design, if you keep researching economics, prior to too lengthy you will run right into worries and also problems that you will have to graph to fix. Both micro and also macroeconomics are described in regards to theories and also models. The a lot of well-known theories are more than likely those of supply and also demand, but you will learn a variety of others.

Key Concepts and Summary

Economists analyze problems in different ways than perform various other disciplinary professionals. The primary tools economists use are economic theories or models. A concept is not an illustration of the answer to a difficulty. Rather, a concept is a tool for determining the answer.

See more: Why Does Occlusion Lead To The Demise Of A Mid-Latitude Cyclone?

Self-Check Questions

Suppose we extfinish the circular circulation model to add imports and also exports. Copy the circular circulation diagram onto a sheet of paper and also then add a international nation as a 3rd agent. Draw a turbulent sketch of the flows of imports, exports, and also the payments for each on your diagram.What is an example of a trouble in the human being now, not mentioned in the chapter, that has an economic dimension?

Resee Questions

How did John Maynard Keynes specify economics?Are families primarily buyers or sellers in the products and also solutions market? In the labor market?Are firms primarily buyers or sellers in the items and 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 concern unchoose anything you have actually ever before done before. Also, expect you carry out not have actually a particular model for analyzing that concern. What must you do? Hint: What would a carpenter carry out in a similar situation?


circular circulation diagrama diagram that views the economic climate as consisting of households and firms connecting in a goods and also solutions sector and a labor marketproducts and also services marketa sector in which firms are sellers of what they create and also families are buyerslabor marketthe sector in which households offer their labor as workers to service firms or other employersmodelwatch theorytheorya representation of a things or situation that is streamlined while including enough of the vital attributes to aid us understand also the object or situation


Answers to Self-Check Questions

Draw a box exterior the original circular flow to reexisting the international nation. Draw an arrowhead from the international nation 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 arrowhead in the reverse direction to reexisting payments for imports.Tright here are many such troubles. Consider the AIDS epidemic. Why are so few AIDS patients in Africa and Southeast Asia treated with the same drugs that are effective in the United States and Europe? It is bereason neither those patients nor the countries in which they live have actually the sources to purchase the very same drugs.