Circular Flow

Suppose, for example, that Mayor Thurgood and the Shady Valley City Council have decided to impose a tax on left-handed citizens. In that the majority of Shady Valley citizens are right handed, this tax would seem to have overwhelming support. The tax burden is paid by a small segment of society. However, with less income, left-handed citizens purchase fewer goods, most of which are sold by right-handed citizens. Right-handed citizens also end up with less income.

The expenditure multiplier is one interesting concept illustrating the complexity of the circular flow. The expenditure multiplier shows that a relatively small change in business investment (or other autonomous expenditures) leads to a relatively large change in national income and gross domestic product.

Suppose, for example, that OmniMotors builds a new factory to produce the OmniMotors XL GT 9000 Sports Coupe. Factory construction workers use a portion of their extra incomes to purchase delicious ice cream treats, resulting in greater sales of Hot Mamma Fudge Bananarama Ice Cream Sundaes. As a result, workers in the Hot Mamma Fudge Bananarama Ice Cream Shoppe benefit with higher incomes. Hot Mamma Fudge Bananarama Ice Cream workers use their extra incomes to purchase Wacky Willy Stuffed Amigos, which benefits Wacky Willy workers.

Externalities

For example, the Mona Mallard Duct Tape factory might release noxious odors into the atmosphere that are, at best, unpleasant and, at worst, unhealthy. This would be a cost external to the duct tape market. At the same time Mona Mallard Duct Tape factory might improve the education of its workforce, which enhances the productivity of other companies as employees switch jobs. This would be a benefit external to the duct tape market.

The seventh rule of complexity further suggests that external consequences can be far removed from the market activity. The external chain of events is often subtle and indirect, resulting in consequences that occur at a different location long after the initial activity.

For example, suppose that the Mona Mallard Duct Tape factory releases chemical waste into the Shady Valley River. This waste travels thirty miles downstream until it reaches the irrigation system of a farm operated by Herb Haberstone. The chemicals are absorbed by Herb's tomato plants, which Herb harvests and sells later that summer in neighboring Oak Town. Zeke Zabrowski buys a bushel of Herb's tomatoes, which he serves at a family reunion attended by his second cousin Valerie Van Hooten from Vancouver. Valerie, a principal actor in the Vancouver Repertoire Theater, is sicken from eating the tomatoes and is unable to participate in a performance of William Shakespeare's Two Gentlemen of Verona. An actor or lesser talent takes over her part, the play receives horrific reviews, the Vancouver Repertoire Theater closes down and hundreds of people lose their jobs. One of those unemployed actors, Clint Steel moves to Hollywood, becomes a major movie action hero, wins several awards, then uses his popularity to be elected Governor of California and subsequently President of the United States. As President he launches programs and policies that lead to a century of peace and prosperity around the globe.

The consequences of an action are often subtle indirect, guided by a series of cause-and-effect links throughout the complex economy.

Scientific Analysis