Question

7. The inhabitants of the fictional economy of Atlantis use money in the form of cowry shells. Draw a circular- flow diagram showing households and firms. Firms produce potatoes and fish, and households buy pota- toes and fish. Households also provide the land and labor to firms. Identify where in the flows of cowry shells or physical things (goods and services, or resources) each of the following impacts would occur. Describe how this impact spreads around the circle. a. A devastating hurricane floods many of the potato fields. b. A very productive fishing season yields a very large number of fish caught. c. The inhabitants of Atlantis discover Shakira and spend several days a month at dancing festivals.

Answer 1

The accompanying diagram illustrates the circular flow for Atlantis.

a.   The flooding of the fields will destroy the potato crop. Destruction of the potato crop reduces the flow of goods from firms to households: fewer potatoes produced by firms now are sold to households. An implication, of course, is that fewer cowry shells flow from households to firms as payment for the potatoes in the market for goods and services. Since firms now earn fewer shells, they have fewer shells to pay to households in the factor markets. As a result, the amount of fac- tors flowing from households to firms is also reduced.

Shells She.ls Houseno.ds Land and Potatoes andfish labor warkets for Factor markets pue spoo8 services Potatoes andfish Land and labor Firms Snells Shelis

b.   The productive fishing season leads to a greater quantity of fish produced by firms to flow to households. An implication is that more money flows from households to firms through the markets for goods and services. As a result, firms want to buy more factors from households (the flow of shells from firms to households increases) and, in return, the flow of factors from households to firms increases.
c.   Time spent at dancing festivals reduces the flow of labor from households to firms and therefore reduces the number of shells flowing from firms to house- holds through the factor markets. In return, households now have fewer shells to buy goods with (the flow of shells from households to firms in the markets for goods and services is reduced), implying that fewer goods flow from firms to households.