The Theory Of The Economy

1261 Words Apr 8th, 2015 6 Pages
Economy is the production, trade, and consumption of limited goods and services by different groups in varied geographical locations. Economists use scientific methods to study the nation’s economy and learn about what drives the supply and demand of certain areas. Economists’ develop theories of how they believe certain aspects of the economy, for example inflation, derive and the test their theories through data collection, analyzing the flow of money, etc. Then they take their research and compare their theories with the collected data to determine if their theories are correct (Mankiw, 1998). Since theories and research in economy can be confusing and difficult economists use models to help interpret and explain how the economy works and how different aspects of the economy affect each other. One of these models is called the circular flow diagram. In some models, the economy is simplified to include only two types of decision makers, firms and households. Firms produce goods and services. Households own the factors of production and consume all the goods and services that the firms produce (Mankiw, 1998).
The following is an example of a circular flow diagram. It is comprised of several different sectors including the household sector, business sector and the government sector. The household sector includes all people seeking to satisfy unlimited wants and needs. This sector is responsible for consumption. It also owns all productive resources. The business sector…
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