No man is an island, entire of itself; every man is a piece of the continent, a part of the main. If a clod be washed away by the sea, Europe is the less, as well as if a promontory were, as well as if a manor of thy friend's or of thine own were.
John Donne, "Devotions Upon Emergent Occasions," 1623, XVII
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In an ideal economy, prices adjust until all markets are in equilibrium. When there is general equilibrium every market in the economy is at its optimum. Reality, however, is always a step behind the ideal of general equilibrium. (Maybe a giant's step.) Four interfering factors are: ill defined property rights, high transaction costs, costly or distorted information, and sheer uncertainty. One can name other factors that interfere: power, time, and war, for example. Economists are thinking more and more creatively about these interfering factors and their consequences for the economy.
The diagram of the circular flow conveys an important insight in economics: everything depends on everything else, however remotely, as John Donne said in the motto. Like the flap of a butterfly's wing in nature's economy, any small event or change will have a ripple effect throughout the market economy. When, for example, consumers pay attention to food labels and start preferring foods with less than 5 percent total fat per serving, food processing firms will search harder for fat substitutes, or will add more spices. Chemical factories making fat substitutes will boom; the spice islands will flourish; antacid pills will rise; all sorts of changes will happen, big and small.
Figure 16-1: The circular flow diagram
The markets for factors of production complete the circular flow. They mediate the supply of and demand for inputs. The markets in the upper part of the circular flow mediate the supply of and demand for goods and services.