Question

Discuss how microeconomics and macroeconomics affect the flow of money within the Circular Flow Model.

Do you think firms could operate without households? Describe how these disciplines relate to the Circular Flow Model.

Answer 1

The circular flow model shows the interdependence of all sectors of an economic system and how they operate in a close and open economy. Micro and macro economic variables such as money supply, demand for goods and services, government purchase, export and import all these affect flow of money from one sector of the economy to other and helps Operate the economy. For example- house hold sectors provide labor to the industries and industries make use of labor to produce goods and services. House hold sectors get payment from the industrial sectors and then purchase products from them . This completes a circle and repeats itself. When government and foreign sectors are added to it the flow of income changes accordingly. Micro economic variables such as demand, price etc play a major role in circular flow, as in demand for a product is dependent on its price and consumer income, consumer income depends on the amount of time they have worked for the industries and likewise money supply in the economy is also influenced by government expenditure and taxes. So there are several ways in which micro and macro economic variables affect the circular flow model.

Firms cannot operate without household sectors as firms and household sectors are dependent on each other. Household sectors provide labor and also demand the final products of the firm. So firms cannot operate without household sectors.