Paulo Dicdican Econ 110-C1

Scenario 1: Economic Circular Flow

A circular-flow diagram represents a relationship between households or customers and
firms or businesses. Households and firms interact in two types of market: market for goods and
services and market for the factors of production. In the market for goods and services,
households purchase the output of goods and services that the firms provide. On the other
hand, the market for the factors of product show firms purchases materials needed for
production from the household. The last aspect of the circular-flow diagram is the flow of money
in the economy. As households provide revenues to the firms, people who earn from these
revenues use their earnings for things they desire. It shows how money, materials, and outputs
are flowing in the economy (Mankiw, 2018).

Although the circular-flow diagram is useful, there are limitations to it. An example is
non-monetary transactions such as barter or trade. This can be commonly seen in households
in which one is willing to trade an item of equal value to the desired item. This shows no
interaction between firms and households. This limitation can also not be pointed out in the
circular-flow diagram since it shows no flow of money to the economy. Circular-flow diagram is
simple and useful, but it is not a perfect tool to draw a complex economy (J, 2021).

Scenario 2: Production Possibility Frontier

In this scenario, the output of the Production Possibility Frontier diagram is the quality of
cookies produced and the main factor of production is the quality of milk produced. Milk is
usually known to be supplied by cows and if a cow disease manages to kill half of the
economy’s cows, the output of cookies which is dependent on the supply of milk will also
decrease.

Production Possibility Frontier 1 shows the normal rate of production when there is no
disease endangering the health of the cows. Production Possibility Frontier 2 displays a smaller
curve since half of the cows’ population was killed off by the disease. The lower population of
cows signifies less milk which results in a lesser quantity of cookies produced.
Sources:

J, A. (2021, November 8). Circular Flow Model. The Investors Book. Retrieved June 28, 2022,
from https://theinvestorsbook.com/circular-flow-
model.html#LimitationsofCircularFlowModel

Mankiw, N. G. (2018). Our Second Model: The Production Possibilities Frontier. In Principles of
Economics (8th ed., pp. 24–24). essay, Cengage Learning.