ECONOMIC MODELS
Start simpleEconomics is really about people and how they behave and that gets messy. If you want to start building a model it is easiest to start simply and build up to a more complex model. Start with ‘households’ and ‘firms’. The household sector was made up of consumers. These are people who owned the economic resources (land, labour, capital and enterprise). They sell their resources to firms that then use them to produce goods and services. This is called production. The firms pay an income for these resources. Households then used these incomes to purchase the goods and services produced by the firms. This is called consumption. This version of the economy a two-sector model.
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Let's make it look more realistic
This simple model does not really represent the economy. For a start, people do not spend all their income on consumption, but instead save part of it. Money is taken out as tax by the government. This means two other sectors have to be added.
These are the financial sector and the government sector. Firms also pay taxes to the government and also saved with the financial sector Money which is saved with the financial sector often returns to firms in the form of investment, while the money from taxation is used for government spending. This new version of the economy is the four-sector model. |
Where can it end?
The diagram shows how each sector is dependent on others through money flows. Savings, taxation and imports are referred to as leakages (money leaving) from the model. Investment, government expenditure and exports are the injections (money entering) into the model.
Because leakages seldom equal injections, the level of economic activity fluctuates. Picture the economy as a fish tank. When more money enters the economy than leaves (injections are greater than leakages) the economy will expand and experience economic growth. When more money leaves the economy than enters (leakages are greater than injections) the economy will contract and experience economic decline. To avoid the problems associated with growth or decline, the government tries to influence the decisions made by sectors to alter the flows of money, in order to achieve the correct balance in the economy. |
The flow of money
Money is the medium used to exchange goods and services. It therefore links the main sectors within our economy: consumers, employers, businesses and governments.
Money is constantly flowing throughout the whole economy. It is what makes our economy function. Oil is the lubricant that keeps your car engine running smoothly; in the same way, money is the oil that keeps our economic system working. Without money we would have to go back to bartering. This would result in fewer and weaker links between the sectors and a lower standard of living.
REMEMBER: it isn't at the heart of economics though, people are. Our attitudes, our expectations, the way our democracy works - that's what holds everything together. Our economy works on principles associated with capitalism where markets act freely and people can own property. These are important differences to communism, socialism and command economies like China. John Maynard Keynes developed these complex models and called them macroeconomic models - the big picture framing economics. He also had a few things to say about capitalism!
Money is the medium used to exchange goods and services. It therefore links the main sectors within our economy: consumers, employers, businesses and governments.
Money is constantly flowing throughout the whole economy. It is what makes our economy function. Oil is the lubricant that keeps your car engine running smoothly; in the same way, money is the oil that keeps our economic system working. Without money we would have to go back to bartering. This would result in fewer and weaker links between the sectors and a lower standard of living.
REMEMBER: it isn't at the heart of economics though, people are. Our attitudes, our expectations, the way our democracy works - that's what holds everything together. Our economy works on principles associated with capitalism where markets act freely and people can own property. These are important differences to communism, socialism and command economies like China. John Maynard Keynes developed these complex models and called them macroeconomic models - the big picture framing economics. He also had a few things to say about capitalism!