Chapter 2 Presentation 2

Circular Flow Model

“The Invisible Hand”

• 1776 book “The Wealth of Nations” by Adam Smith• -private industries seeking to further

their own interest will simultaneously, as if guided by an invisible hand, promote social/public interest

Invisible Hand Example

• Businesses use the least costly combination of resources to maximize profits• Uses the least amount of scarce

resources which “frees up” resources

Profits

• Total Revenue (TR) – Total Cost (TC)• Total cost can include both explicit

(money paid to gain resources) and implicit costs (what a resource could have earned through an alternative cost • Implicit Cost Ex- renting out a building

instead of using it

Circular Flow Diagram

Resource/FactorMarket

ProductMarket

Businesses Households

Both Flows Are Equal

GovtGoods/services

Taxes

Taxes

Goods/services

Resource/Factor Market

• The place where resources or the services of resource suppliers are bought and sold

• Resources are natural, human, or manufactured items that help produce goods and services

• Households (people) own all economic resources directly as workers/entrepreneurs or indirectly through their ownership of corporations

Resource Market Contd.

• The funds that businesses pay for resources are costs to them but flow to individuals as wage, rent, interest and profit• Resources flow from households to

businesses and money flows from businesses to households

Product Market

• The place where goods and services produced by businesses are bought and sold• Businesses combine resources to

produce and sell G/S and households use their income used from the sale of resources to buy goods and services