Those homemade fries come from potatoes-a natural resources-bought from a local farm, which is owned by a household. You are selling and the diner is buying your labor resources. The business buys these economic resources from households.įor example, let’s say you work at the diner. A diner:it uses a mix of economic resources, such as land-potatoes for fries labor-cooks and wait staff, and capital-kitchen equipment and cash register resources to produce goods and services-in this case cheeseburgers, fries, and milkshakes. Let’s look at some transactions in the market for resources by a business. Whether a small diner owned by an individual, a partnership owned by several individuals, or a corporation owned by stockholders, all of these businesses are owned by people who are also members of a household. But who owns the businesses? You guessed it-households. You might think of capital, say a delivery truck, as being owned by a business. Notice that it is households who own all the economic resources. The market for resources is where households sell and businesses buy economic resources-land, labor, capital, and entrepreneurial ability. And, businesses may produce goods, such as computers and bicycles, and services, such as haircuts and car repairs.īut households and businesses are not isolated, they interact in markets.Īt the top of the model we have the market for resources. Businesses can be large, such as an automobile manufacturer, or small, such as a diner. A business is a privately owned organization that produces goods and services and then sells them. So, an entrepreneur might combine land, labor, and capital in new ways-taking risks along the way-to bring a good or service to market. For example, think of a hammer used by a carpenter or a computer used at a business.įinally, entrepreneurial ability is the human resource that combines the other resources to produce new goods and services and bring them to market. Labor is just what it sounds like-work for which you are paid.Ĭapital resources are goods used to produce other goods and services. For example, these could be actual land owned by a farmer or other natural resources such as oil, water, and trees. The economic resources are land, labor, capital, and entrepreneurial ability. Households own all the economic resources in the economy. Households consist of one or more persons who live in the same housing unit, such as a family. Let’s start with the two groups of economic decision-makers. While the real economy is much more complex, the simple circular flow model is useful for understanding some key economic relationships. The circular flow model shows the interaction between two groups of economic decision-makers-households and businesses-and two types of economic markets-the market for resources and the market for goods and services. Before you know it he will spend it, and the cycle will begin again. That money won’t remain in his wallet forever, though. Let’s say your money goes to the farmer, and that for him is income. All of these are costs of production.Īfter she has paid her costs of production, the remaining revenue is her profit-the income she earns as an entrepreneur owning and operating her diner. She buys homegrown potatoes from a farmer pays the server, who took your order, his wages and makes a payment on the loan she got to buy new equipment for the diner. But the money doesn’t remain in the cash register for long.Īlice, the diner owner, uses the money to purchase resources. When you pay your check, you are buying goods and services. You take your money to the diner for a tasty meal. Imagine you are a hungry consumer who hears the homemade fries at the diner down the street calling your name. To demonstrate the usefulness of the circular flow model, let’s follow a few dollars through a cycle. The circular flow model highlights the “flows” within the economy-the flow of economic resources, goods and services, and the flow of money. One of the most useful is the circular flow model. Luckily, economists have developed models to help us learn and understand how the economy functions. Let’s face it, the economy is complex and can be difficult to understand. Read more about our award-winning resources » This video received the 2015 Curriculum Silver Award from the National Association of Economic Educators and was a 2014 Gold Winner of the AVA Digital Awards. More episodes featuring economic concepts:
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