Running head: FUNDAMENTALS OF MACROECONOMICS 1

Fundamentals of Macroeconomics

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Introduction

The simple unit of economic theory is the typical circular flow model that an economic

system strictly upholds. This model illustrates the exchange of various goods, services, as well as

factors of production occurring among different categories of economic players, the government,

producers (firms) and consumers (households). On the other hand, the environment as well as the

natural resources do not have their inclusion in the typical version of this model even though

they make the economic production conceivable. The circular flow model offers a representation

of the interconnection among the various features of the economy. As a comparison, it offers a

representation of the “forest”. It is vital to examine the specific “trees” in detail to help in

elucidating the major players in the economic market. This examination gives the fine points of

the several characteristics of the economy and understand their interconnectedness; thus,

businesses and their consumers can realize reasons behind the economic difficulties of

unemployment, slow economic growth or inflation as well as how to reach their solutions.

Purchase of Groceries

Businesses and households connect in the circular flow model in such a way that their

interdependence show a mutual relationship. Households and businesses always work together if

any purchase activity occurs between them. When an individual from any household visits a

store to buy groceries for the family, his shows active participation in the market for

consumption. By giving money to the owner of the grocery store, this allows the buyer to acquire

the groceries he required. Households, in the product market, purchase goods as well as services

from businesses with money as the means of exchange.  Conversely, in the aspect market, the

businesses employ labor from the households with money as the exchange product. This flow
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carries on continuously. Households work together with companies in the factor market

whenever someone receives payment to work for a company.  This shows that the individuals

sells his labor skills as the company uses money as a means of exchange for its labor, which is a

factor of production. Such employees might go ahead and purchase groceries from other

businesses as the circle continues. People take the roles of both consumers and producers. When

households purchase goods and services produced by businesses produce, they act as consumers.

Purchasing foodstuff at a local grocery shop shows an example of the exchange in a product

market.

Massive Layoff of Employees

As resource proprietors, people function as producers by providing useful resources to industries,

which use the resources to manufacture goods and services. These exchanges occur in resource

markets or input markets. Instances in which such transactions take place in resource markets are

when businesses pay salaries to workers, rent payment to landlords or interest on loans intended

for plant and equipment. This simple model, though, has two problems.  First, businesses have

the uncertainty about the quantity of products consumers will buy.  Second, households have the

uncertainty about the quality of resources businesses want to hire.  These cycles of uncertainty

show that if production in businesses rises so high, this creates an impermanent boom in

production and employment.  Eventually, this result into a surplus of products, a successive drop

in prices and the producers forced to massively layoff employees to cut costs.  The consequence

is unemployment and recession.  Comparatively, the housing boom and bust in the U.S. followed

this arrangement.  Ultimately, the remaining labor resources causes the value of employment to

drop in such a way that businesses will find it cheap to hire more labor force and production

starts to rise again. Therefore, the order of boom and bust or the business cycle is an expected
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scenario in the open market as no man can forecast the future correctly all the time. From the

preceding, it is evident that the significance of upholding full employment is creation of jobs. If

creation of new jobs takes place at an appropriate rate to absorb those exiting old jobs in addition

to new players to the workforce, the economy can experience massive layoffs and yet not have a

remarkably high rate of joblessness.

Decrease in Taxes.

A circular flow model covers three subdivisions (household, business and government) as well

as three markets (product, factor, and financial). The preceding demonstrates the unceasing

movement of the disbursements for products amongst the producers and consumers, with

specific stress on taxes and government procurements. The three-sector, three-market circular

flow model illustrates the significant part that the government sector takes in the economy. It

enlarges the model by demonstrating how the diversion of taxes occur consumption expenses to

the government sector that are again put into use in government procurements. It shows that

taxes do not disappear from the economy, but simply diverted. Economists might identify a

recession, but it may take some time for governments to legislate a simulative tax cut or

expenditure program. However, price regulation have been questioned as a remedy. If inflation

were to begin again, economists might propose “supply side” procedures that would decrease

taxes and guidelines that might increase prices. On the other hand, the government uses fiscal

policy by injecting tax cuts or upsurges in government expenditure to improve the economy.

Finally, people pay taxes based on their earnings, on the things they purchase or on the property

they possess. The taxes collected signify the main source of revenue to the government sector.

Hence, the reduction of taxes leads to loss of government revenue.

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Conclusion

The preceding information articulates a systematic analysis of processes contained in the typical

circular flow model. The model inaugurates some abridging assumptions that may not be

representative; but gives a general impression of understanding the main arguments of the model.

In each succeeding step, the model shows factors that are more realistic that the households,

businesses and the government interconnect with to give a good impression of the model. The

model resembles a road map, which gives direction and distance but does not display every

bump in the road or every corner. In other words, the model does not show a detailed structure of

the economy. Business managers need to know deeply about this model because, as producers,

businesses compete against each other in the resource markets while purchasing, mainly from the

household sector. The government comes in as the economy has restricted quantity of economic

resources. The budget of procuring resources such as labor is a source of earnings for

households, which the business managers need to organize for as the labor resource payers.