WHAT DOES A CIRCULAR FLOW DIAGRAM REPRESENT?

CIRCULAR FLOW DIAGRAM

A circular flow diagram is an economic model which is built on some assumptions and they are:

1. There are only two participants in the market i.e. households and firms
2. The market is not regulated
3. There are no exports or imports
4. The output is equal to the inputs

• As mentioned earlier that there are two participants in the market and they are households and firms.
• Households are the consumers and firms are the producers.
• Households consume goods but they supply factors of production namely land, labor and capital.
• Firms produce goods but they require factors of production
• The outer circle in the diagram represents the flow of inputs whereas the outer circle represents the flow of dollars 

OUTER CIRCLE 

• If we start from the top product markets supply goods to the households. 
• The households consume the products and provide factors of production to resource markets
• These resource markets provide the resources to the firms and firms use the resources to produce goods and services
• Now we come to the inner circle

INNER CIRCLE

• Again we start from product markets. The revenue collected by the product markets is given to the firms
• The firms use this revenue to pay for the factors of production
• This payment is a source of income for households 
• The households then spend their income in purchasing goods from the product markets.

The link http://www.econforkids.com/CE-Lesson7.pdf illustrates the circular flow diagram in a very simple way.

The above video explains the circular flow diagram comprehensively

HOW TO PLOT DEMAND AND SUPPLY CURVE IN EXCEL?

If we have a simple demand schedule and supply schedule, how do we plot it in excel?

I will be explaining this step-by-step with the help of a video.

The demand and supply schedule are not clear in the video so I have created one for your understanding.

PRICE IN DOLLARS	QUANTITY DEMANDED	QUANTITY SUPPLIED
4	135	24
5	104	52
6	81	81
7	68	93
8	53	110
9	39	121

1. First highlight the columns of price, quantity demanded and quantity supplied 
2. Click on "Insert" tab and click on Scatter graphs
3. Choose smooth scatter graph or scatter with straight lines
4. When you do this the price will not be on the y-axis. To fix that click on the right click on the graph. Then click on select data
5. Select quantity demanded and click edit
6. When you do that a box will appear which has three text boxes. In the first text box write quantity demanded
7. In the second text box which asks you about the x values, highlight the quantity demanded column
8. In the third text box which asks you about the y values, highlight the price column
9. Repeat the above three steps for supply
10. Now you will have price on x-axis and quantity on y-axis
11. The supply and demand curve will intersect at a point which is your equilibrium point

HOW IS PRICE ELASTICITY OF DEMAND COMPUTED?

We have already studied what elasticity of demand is. Now in this post i will be explaining how to compute the price elasticity of demand.

PRICE ELASTICITY OF DEMAND

Price elasticity of demand measures how much the quantity demanded responds to a change in price. As explained in previous post demand for a good is said to be elastic if quantity demanded responds substantially to changes in price. Demand is said to be inelastic if quantity demanded responds only slightly to changes in price.

(cited from Gregory Mankiw's Essentials Of Economics)

FORMULA

OR

The price elasticity of demand is always negative because with the increase in price the quantity demanded falls but we usually ignore the negative sign and take absolute values.

In the video an example is given to show how the above formula is applied.

MIDPOINT FORMULA

There is another formula which is known as Midpoint formula by the price elasticity of demand can be calculated. This formula gives us a consistent answer.  

 

ELASTICITY OF DEMAND

ELASTICITY

Elasticity of demand measures how flexible consumers are to changes in price. Hence the picture of a rubber band.

Elasticity of demand is a very easy topic if it is understood first in general terms.

Consider that the price of going to a doctor rises. Due to the rise in price people will not stop going to the doctor because it is a necessity. However if the price of mercedes rises people will buy a cheaper car instead because mercedes is a luxury car. So the demand for going to the doctor is inelastic whereas the demand for mercedes is elastic

ELASTIC GOODS

Olive

Chocolate milk

Hamburgers

INELASTIC GOODS 

Oil

Milk

Food

Food is inelastic because there is no substitute for it. But hamburgers are elastic because there are substitutes for them. Milk is inelastic because there is no substitute for it but chocolate milk can be substituted by vanilla flavoured milk. Similarly oil has no substitute but olive oil can be substituted by vegetable oil. Therefore oil is inelastic and olive oil is elastic.

In the video the concept of elasticity is introduced. It explains elasticity and its effects on revenue.

What happens to revenue when a demand is elastic or inelastic? 

While explaining taxes I explained what is meant by revenue. In this video it is explained what happens to revenue if the demand is elastic and when it is inelastic. This picture below will help you in understanding the effects of the elasticity or inelasticity on revenue.

WHAT IS MEANT BY A TAX?

A lot of people get confused when they study taxes. So in this post i will be explaining taxes.

TAX

Tax is an important policy instrument usually imposed by the government either on buyers or on sellers.

First we will deal the tax on buyers. If the tax will be on buyers the demand curve will shift to the left in a magnitude which is equal to the tax i.e the vertical distance between the old and new demand curve will be equal to the tax
.

• In the figure you can see that when there was no tax imposed the equilibrium quantity and equilibrium price were Q1 and P1 respectively.

• But when the tax is imposed the demand curve shifts to the left (not shown in the diagram) and new equilibrium price and quantity are Q2 and P2 respectively.

• But P2 is the price received by the sellers as it is the lower price whereas we can calculate the price paid by the buyers can be calculated by extending a vertical line to the original demand curve. This will give us the price paid by the buyers which is P3.

• Now let us consider that the tax on the sellers then the supply curve will shift to the left to a distance equal to the tax and now the new equilibrium price and quantity will be P3 and Q2.

• Here P3 is the price paid by the buyers. To find the price received by the sellers we will draw a vertical line from new equilibrium point to the original supply curve. And so the price received by the sellers is P2.

• You must have noticed that whether the tax is on buyers or on sellers the price paid by the buyers is always greater than the price received by the sellers.

• This is because a tax distorts the market in such a way that both buyers and sellers are worse off

• Now let's talk about the tax in terms of surplus

• Before the tax the consumer surplus was A+B+C but after the tax it was A

• Before the tax the producer surplus was D+E+F but after the tax it was F

• Now you must be wondering what happened to B+C+D+E

• When government imposes a tax it gets revenue which can be calculated by multiplying the quantity after the tax with the magnitude of the tax. i.e. B+D

• And C+E is the dead weight loss. What is meant by a deadweight loss? It the loss of surplus that results from tax.

WELCOME TO ONLINE ECONOMICS TUTORIALS

"Economics has never been a science - and it is even less now than a few years ago"                    -Paul A. Samuelson

This is my first blog...I hope it helps you in understanding some basic principles of economics...:)