Economic Models

Read this section on the reasoning behind economic models, which are just representations of reality or theoretical thinking for understanding something. Pay attention to the explanation about the Circular Flow Diagram (Figure 2), which represents how the economy and its actors are related to one another. Make sure to answer the quiz questions.


circular flow diagram:
a diagram indicating that the economy consists of households and firms interacting in a goods-and-services market and a labor market

goods and services market:
a market in which firms are sellers of what they produce and households are buyers

economic model:
is a simplified version of reality that allows us to observe, understand, and make predictions about economic behavior

labor market:
the market in which households sell their labor as workers to businesses or other employers