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1. Economic models
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 arrow
...
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1. Economic models
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.
Which of the following is true regarding this economic model?
Because, in reality, the economy is very large, the simplicity of the circular-flow diagram makes it
useless for the purposes of modeling how dollars and resources move throughout an economy.
While simple, the circular-flow diagram can still be useful for the purposes of modeling how dollars
and resources move throughout an economy.
Because it does not take into account the role of government, the circular-flow diagram is useless
for the purposes of modeling how dollars and resources move throughout an economy.
Because it does not take into account international trade, the circular-flow diagram is useless for
the purposes of modeling how dollars and resources move throughout an economy.
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Explanation:
Scientists of all types make assumptions in their models to simplify the complex world they are trying
to describe. These simplifying assumptions allow scientists to focus on only the most important and
generalizable components of the topic of study.
Economists also make simplifying assumptions to focus on only the most important and generalizable
aspects of the economy. Indeed, economies typically consist of millions of individuals interacting in
many different ways. However, no model can include every detail of a system as complex as an
economy. To make sense of all of the different aspects of an economy, economists must make
simplifying assumptions and generalizations in order to focus on only the most important economic
ideas. By grouping all individuals into households and firms and all markets into markets for goods and
services and markets for factors of production, economists can model how dollars and resources flow
back and forth among agents in the economy. The simplicity of the model allows those without formal
backgrounds in economics to understand, at a high level, the economic activities that take place in an
economy.
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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.
Based on this model, households earn income when firms purchase resources in
resource markets.
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Explanation:
In the circular-flow model of an economy, households own all the resources. Households earn their
income when firms purchase or rent these resources to use them to produce goods and services.
Firms, in turn, earn revenue when households buy goods and services.
Suppose Megan earns $800 per week working as jewelry appraiser for Classy's Jewelry Store. She uses
$10 to buy a box of aspirin at Pillmart Pharmacy. Pillmart Pharmacy pays Larry $475 per week to work
the cash register. Larry uses $300 to purchase necklace from Classy's Jewelry Store.
Identify whether each of the following events in this scenario occurs in the resource market or the
product market.
Event
Resource
Market
Product
Market
Megan earns $800 per week working for Classy's Jewelry
Store.
Larry spends $300 to purchase necklace from Classy's
Jewelry Store.
Megan spends $10 to buy a box of aspirin.
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Explanation:
In this scenario, households sell resources in resource markets when Megan supplies her labor to
Classy's Jewelry Store and when Larry supplies his labor to Pillmart Pharmacy. Moreover, a firm sells
goods and services to a household in product markets when Pillmart Pharmacy provides the aspirin to
Megan and Classy's Jewelry Store provides the necklace to Larry.
Which of the elements of this scenario represent a flow from a firm to a household? This could be a
flow of dollars, inputs, or outputs. Check all that apply.
The $300 Larry spends to purchase necklace from Classy's Jewelry Store
Megan's labor
The $475 per week Larry earns working for Pillmart Pharmacy
The aspirin Megan receives
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Explanation:
When Megan (a household) supplies her labor to any firm, labor is an input that flows from a
household to a firm.
When the aspirin is provided to Megan (a household), the aspirin is an output that flows from a firm to
a household.
Pillmart Pharmacy (a firm) pays Larry (a household) $475 for his labor. Therefore, the $475 is a
payment that flows from a firm to a household.
Larry (a household) pays Classy's Jewelry Store (a firm) $300 for necklace. Therefore, the $300 is a
payment that flows from a household to a firm.
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3. Efficiency in the production possibilities model
Suppose Ireland produces only two goods: corn and smartphones. The following graph shows Ireland's
current production possibilities frontier, along with six output combinations represented by black
points (plus symbols) labeled A to F.
C
omplete the following table by indicating whether each point represents output combinations that are
inefficient, efficient, or unattainable. Check all that apply.
Point Inefficient Efficient Unattainable
A
B
Point Inefficient Efficient Unattainable
C
D
E
F
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Explanation:
Every output combination on the production possibilities frontier shows an efficient output
combination for Ireland. The points on the production possibilities frontier represent all combinations
of output produced using all of the nation's available resources and its current technology, such that
the nation cannot produce more of one good without producing less of the other.
Points located inside the production possibilities frontier, such as C and D,
represent inefficient output combinations. At these points, it is possible to increase the production of
both goods because some resources are unemployed. For example, point C is inefficient because it is
possible for Ireland to produce at point B instead, where the economy is producing both more corn and
more smartphones.
Points located on the production possibilities fronti
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