Circular Flow Diagram

Circular Flow Diagram

The circular flow diagram is a model of a specific goods market. Households provide the factors of production (Land, Labor, Capital and Entrepreneurship] in factor markets. Firms buy those factors and produce goods and services in the goods market which is then bought by Households. The expenditure from the Households provide the Firms with ways to repay the Factors of Production (through Wages, Rent, Interest, and Profit) which means that the profit from the Goods Market is circulating to the Factor Markets while the produces of the Factor Markets is circulating to the Goods Market. As a circle is infinite and continuing; so is the circular flow diagram.

Circular Flow Diagram

Circular Flow Diagram

The circular flow diagram is a model of a specific goods market. Households provide the factors of production (Land, Labor, Capital and Entrepreneurship] in factor markets. Firms buy those factors and produce goods and services in the goods market which is then bought by Households. The expenditure from the Households provide the Firms with ways to repay the Factors of Production (through Wages, Rent, Interest, and Profit) which means that the profit from the Goods Market is circulating to the Factor Markets while the produces of the Factor Markets is circulating to the Goods Market. As a circle is infinite and continuing; so is the circular flow diagram.

R1: Rational Behaviour

Economics studies the choices that people make. These choices are heavily influenced by scarcity and incentives. People use rational decision making to choose based on their common sense and personal preferences.

Economists use the assumption of rational behavior to observe why they make the choices they do. This allows them a view into common sense and general preferences. Also it would take into consideration of the data or the information that led the person in question to make this choice. To study the choices that people make, one must know the facts they knew and understand common sense. If added together; the facts and common sense will lead to a rational decision that the person has made or would make. 

But there are times when people would choose irrationally but that can be avoided if given incentive (a reward or penalty). Self-control is necessary to choose wisely and in our self-interest at times.