Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. a. Selena pays a storekeeper \(\$ 1\) for a quart of milk. b. Stuart earns \(\$ 8\) per hour working at a fast-food restaurant. c. Shanna spends \(\$ 40\) to get a haircut. d. Salma earns 820,000 from her 10 percent ownership of Acme Industrial.

Economic transactions are the cornerstone of any economy, symbolizing the exchange of goods, services, or money between parties. In the context of the circular-flow diagram, these exchanges are represented as the interactions between households and firms. For example, when Selena pays a storekeeper for a quart of milk, she is engaging in an economic transaction that involves the flow of dollars to the firm and simultaneously, the flow of goods, the milk, to her household.

Every economic transaction has two facets in this model: one party providing a service or good and the other party compensating with money. Stuart's work at a fast-food restaurant is another instance where his labor—considered as a service—is provided to the firm, and in exchange, he receives wages. This back-and-forth of goods, services, and money keeps the economic engine running and is visualized by the circular-flow diagram.

The flow of goods and services indicates the direction in which physical products, as well as intangible services, are being exchanged in an economy. In the inner loop of the circular-flow diagram, we visualize this path. A quart of milk moving from a store to Selena represents goods flowing from firms to households, while the work Stuart performs for a fast-food joint exemplifies services flowing in the opposite direction.

Real and Intangible Flows

Not all flows are tangible. Shanna's haircut is an intangible service that moves from the salon to her, reflecting the constant activity and diversity within this flow. Whether we're talking about a physical good like milk or a service like a haircut, they are essential parts of the economic puzzle, which the circular-flow diagram helps us understand through its simplified representation.

Parallel to the exchange of goods and services is the flow of dollars. In the outer loop of the circular-flow diagram, money is the focus. Selena's payment for the milk is depicted as dollars flowing to the firm, and the same goes for Shanna's haircut. Money—whether for goods or services—always moves in the opposite direction to the physical or intangible product.

Wages, Rent, and Profits

Different forms of money flow include wages, like Stuart's earnings, rent or dividends from investments, as in Salma's case. The diagram simplifies complex economic relationships and transactions into a flow that is easy to understand, underlining the importance of monetary circulation within the economy.

In the circular-flow diagram, households and firms are the two actors playing the lead roles. Households are consumers of goods and services while providing labor, capital, and other resources. Firms are producers of goods and services and they hire the resources offered by households.

Interdependence and Interaction

These two groups are interdependent: households need the goods and services produced by firms, and firms need the resources—labor, capital, and land—that households provide. This interconnectedness is the engine of the economy, with each group relying on the other for its survival and success, a relationship vividly captured in the circular-flow diagram.