What important feature of the economy does the circular-flow model ignore?

Question

What important feature of the economy does the circular-flow model ignore?

Answer 1

I am playing very big on oil trading, from Morgan Stanly,  Goldman & Sachs on the Wall Street .

I bought millions and millions of barrels of oil when they cost $60--$100 a barrel. I expect to make a kill when I sell. But right now it’s only $145 a barrel. So here is my difficulty:

I already requested my agents spin the media, like: “Oil future looks high, expecting to be in the range of $200 a barrel soon. ”   But it does not work price up as fast as I expected.

I have also demanded my agent playing “China demand high” blaming game.

I am glad to see that Congress is ignoring 19 top trade group’s letter demanding an end to rampant oil speculation

Also I  am happy to see that the Media did not report it as I  desired.

But how do I corner the oil future price up very fast ?  fast enough in time so not to get caught ?

Answer 2

The service sector often has Leontief type production functions.  This can create a situation where a market cannot clear.  Imagine for example a case where the market needed 20,000 taxis to perform the function taxis perform.  Now imagine a case of a deep recession, as is happening in Detroit, where the number of people move away and the demand falls to 15,000 taxis.  If 5,000 taxi drivers are laid off, you probably cannot sell all or maybe any of the taxis at any price since the rest of the country is in a recession.  So capital just kind of sinks out of the model.  It isn't depreciated, but in a Leontief production function you cannot substitute capital for labor, so it is much like a depreciated model, except that because it exists it acts as a cap on new inventory purchases and acts like a fixed variable in an otherwise fluid economy.

The circular flow model is a market clearing model.  The existence of Leontief production functions can stop the circular flow.

This is probably not what your instructor is looking for, but the circular flow model does not contemplate situations where there is no use for a spare 5,000 taxi cabs since you cannot substitute them for other uses.

Answer 3

So, e circular flow model is an accepted way to show the flow of goods and services in a market economy. In a mixed economy, the government plays an important role as well, but this is not shown in the circular flow model. Local, state, and federal governments also produce, or cause the production of, goods and services. Schools, highways, water-treatment plants, parks, and other facilities are examples of government spending. Governments take part of household incomes in the form of taxes, but they also inject money back into households in the form of wages. Some of that money goes back to the government in the form of taxes and still more goes into other places.

The government has considerable control over the economy, which in turn affects production, employment, and economic growth. If interest rates go up, households will purchase fewer goods and services. If interest rates go down, households will spend more. This spending adds to or takes away from businesses' operations and the amount of goods and services being produced.

Governments can influence the mix of goods and services offered to households. Good examples, although they might seem rather extreme, are when the government ordered the breakup of the Bell Telephone System and later of Microsoft Corporation because it was determined that they violated antitrust legislation and had become monopolies. This kind of breakup affects business operations and households.

The model that is shown in Figure 1 could also be influenced by pricing factors—that is, the laws of supply and demand. The model does not take into consideration changes in prices or how prices are determined. Nor does it take into consideration how businesses choose the products or services they produce and market.

Another limitation of the model as presented here is that not all the products and services offered by businesses go to the households that provide the resources. For example, some of the electronic equipment produced in the plant described earlier might be exported to another country. In that case, the goods and services leave the circular flow and the resources to pay for the goods and services come from outside the circle. It might be easier to simplify the explanation and include all households and all businesses in the world, but most economists would not agree with that simplification.

While readers should be aware of the influence that government, exporting and importing, and pricing and production has on businesses and households, it is not necessary to alter the circular flow model. It remains a viable illustration of what happens in a macroeconomic sense without microeconomic influences.

It is also considered by some to be a limitation when money leaves the circular flow to be invested in savings, stocks, bonds, and other financial investments. However, the discussion here assumes that the money that is invested does not really leave the circle, but rather is passed on as a resource to others. It is true that some money does leave the circle because banks and other financial institutions are required by law to maintain a certain amount of money on deposit. And because some individuals in households don't trust banks or other financial institutions, they use the "coffee can" approach to saving their money—they simply keep their savings at home.

Some of the important areas that the Circular Flow does not cover include:

* The environment (externalities - negative extras - like pollution)

* Aid & Charity (as it has no flow)

* Level of government intervention in the economy - the government intervenes for many reasons - such as market failure - this changes the circular flow

I hope this helps.

Answer 4

To hazard a guess, I would say people's expectations about what's going to happen in the future.