We're going to learn about the circular flow of income model today. Or at least, that's what we economists call it.
In more simple, less convoluted English, we're going to learn about a model that is seemingly simple, yet retains the power to shed light on the most complicated concepts in economics. Get a grasp of what's going on here, and you are halfway through to Mount Economics Nirvana.
Promise.
Here goes: economists tend to view the world through a special lens. Through this lens, the world appears grouped into certain categories. These are, in no particular order: households, firms, the government, the international economy and the financial system.
Any economic interaction in the real world is necessarily going to involve two or more of the entities above. If you step out of your house (households) to buy groceries (firms), you have done a transaction that is of interest to a member of my tribe. If the grocer (firms) was present at the local wholesale market (firms) to stock up his vegetables, the grocer was party to a transaction that is of interest to a member of my tribe.
If both you (households) and the grocer (firms) paid taxes (government) - and so on.
Economists like to focus on any one of these entities in isolation and study their particular (and often peculiar) characteristics. Focusing on households alone, for example, might lead economists to ask questions along the lines of "Will the demand for coffee go down if the price of sugar rises? If yes, to what extent?". We would be talking about microeconomics in this case, and particularly the case of consumer equilibrium.
Focusing on firms, on the other hand, would lead to questions along the lines of "Given that workers expect me to pay 100 rupees every hour, and the cost of renting a bulldozer is 1000 rupees for the day, what combination of workers and bulldozers should I be hiring in order to get my work done?". That would be microeconomics again, and particularly the case of producer equilibrium.
A laser like focus on governments would land you in the realm of public economics, while the study of those features that arise out of international trade falls under the domain of international economics. Behavioral economics, a field of study that is proving to be extremely exciting (and counter-intuitive), would focus on consumers and their inherent irrationality.
The point is this: any subject within economics can be quite neatly, and satisfactorily slotted into any of the entities we just spoke about.
Here's where economics gets really interesting though - the study of each of these in isolation is one thing. Studying the big picture - the whole thing - at one go can be unbelievably messy, unpredictable and (surprise, surprise) controversial. That would be the field of macroeconomics, and one which is going through a bit of an existentialist crisis at the moment.
But we're getting ahead of ourselves.
In the next post, we'll examine our model a little more thoroughly. And cross those other bridges when we come to them.
Any economic interaction in the real world is necessarily going to involve two or more of the entities above. If you step out of your house (households) to buy groceries (firms), you have done a transaction that is of interest to a member of my tribe. If the grocer (firms) was present at the local wholesale market (firms) to stock up his vegetables, the grocer was party to a transaction that is of interest to a member of my tribe.
If both you (households) and the grocer (firms) paid taxes (government) - and so on.
Economists like to focus on any one of these entities in isolation and study their particular (and often peculiar) characteristics. Focusing on households alone, for example, might lead economists to ask questions along the lines of "Will the demand for coffee go down if the price of sugar rises? If yes, to what extent?". We would be talking about microeconomics in this case, and particularly the case of consumer equilibrium.
Focusing on firms, on the other hand, would lead to questions along the lines of "Given that workers expect me to pay 100 rupees every hour, and the cost of renting a bulldozer is 1000 rupees for the day, what combination of workers and bulldozers should I be hiring in order to get my work done?". That would be microeconomics again, and particularly the case of producer equilibrium.
A laser like focus on governments would land you in the realm of public economics, while the study of those features that arise out of international trade falls under the domain of international economics. Behavioral economics, a field of study that is proving to be extremely exciting (and counter-intuitive), would focus on consumers and their inherent irrationality.
The point is this: any subject within economics can be quite neatly, and satisfactorily slotted into any of the entities we just spoke about.
Here's where economics gets really interesting though - the study of each of these in isolation is one thing. Studying the big picture - the whole thing - at one go can be unbelievably messy, unpredictable and (surprise, surprise) controversial. That would be the field of macroeconomics, and one which is going through a bit of an existentialist crisis at the moment.
But we're getting ahead of ourselves.
In the next post, we'll examine our model a little more thoroughly. And cross those other bridges when we come to them.
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