Suppose a major news headline reports a sudden increase in unemployment. How would this event affect the circular flow diagram in a typical economy?

• A. It would increase the flow of resources from households to firms, leading to higher production.
• B. It would decrease the flow of income from firms to households, reducing household spending in the product market.
• C. It would have no impact on the circular flow diagram, as unemployment does not affect economic flows.
• D. It would increase the flow of goods and services from firms to households, boosting household consumption.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the circular flow diagram, which illustrates the continuous movement of money, resources, goods, and services between households and firms in an economy.
2. Step 2: Recognize that households provide factors of production (like labor) to firms, and in return, firms pay households income (wages, rent, dividends). This income enables households to purchase goods and services from firms.
3. Step 3: Analyze the impact of a sudden increase in unemployment, which means fewer households are supplying labor to firms, leading to a reduction in income paid by firms to households.
4. Step 4: Understand that with lower income, households have less money to spend on goods and services, which decreases the flow of spending in the product market from households to firms.
5. Step 5: Conclude that the main effect of increased unemployment is a decrease in the flow of income from firms to households, which reduces household spending and thus affects the overall circular flow of economic activity.