1.1.2 The embedded economy

Models are simplified representations of our world. We use models every day to communicate ideas, understand complex processes and make projections or predictions. You may have seen models of an atom, the solar system, or the water cycle in school. These models simplify reality, omitting some details to focus on key ideas and help you understand something new. Models are always incomplete, but still useful, although some are more useful than others.

How do you think the planetary health diet model in Figure 1 has been simplified? 

Why do you think the creators of the model choose to omit some information?

Because models are simplified representations of reality, the creators have to decide what to include and exclude based on what they think is important. Model creators also often need to think about the purpose of their model and who will use their models, making sure their model is relevant for the questions it aims to address.  You should always consider what information might be missing in a model and if the model is useful for your purpose.

The economy is all the human-made systems we use to transfer and transform energy and matter to meet our needs and wants. Economics is the study and practice of how we organise ourselves to do that.

Economic systems are complex, with many parts and many interactions between the parts. Economists use models to represent complex economic systems. Economic models come in different forms such as mathematical equations, computer models, conceptual models and diagrams. All human beings also have mental models of the economy. These are a kind of mental short-cut for understanding how the economy works and our role in it. 

Models can visualise our understanding of how the world works, but they also affect our thinking of how the world works. When we learn about or use a model, it shapes how we think about the world.  So it is important that we use the right model for the right purpose and adjust them as the context changes. If we use inadequate models, they can give us false information about how the economy works. Good models are an important part of shaping economies that support human and ecological thriving.

The circular flow of income model

The model has two groups, households and firms (businesses), that interact in markets, where goods and services are produced, consumed, and exchanged for money. Groups in the economy are also sometimes called agents or stakeholders.

Some households sell their working labour to firms in return for wages. Some rent or sell their land or property to firms, while others invest their savings in return for a share of business profits. Households then use these different sources of income to buy the goods and services that firms produce. In this way, both incomes and resources circulate round and round.

This model is useful for showing the flow of money and resources or products back and forth between businesses and households in a cycle. Sometimes economists also use a more complex circular flow model that includes the money and services exchanged with the government, financial institutions like banks, and foreign countries.

This circular flow of income model is often used in economics textbooks to illustrate the core relationships in an economy, but it is missing some important information to be really useful for that purpose. If you read Section 1.1.1, you may already have some ideas about what’s missing? 

The embedded economy model

Within the economy, there are four main provisioning institutions, organised groups of people with different roles and ways of organising to meet human needs and wants: household, market, state and commons (Figure 4). These institutions have complex relationships with one another, influenced by culture, policy, law, history, power, and technology.

Figure 4. The four main provisioning institutions in economies

The economy is embedded within society. The economy itself is a social system, created and shaped by humans and other social systems including political, cultural and legal systems. Culture, norms, values and human relationships have an impact on how the household, market, state and commons behave and how much of a role each one has in meeting human needs in different societies.

Both the economy and society are embedded in Earth’s life-supporting systems. All economic activity relies on transferring and transforming energy and materials that come from nature. All economic activity also creates waste, either in the form of waste heat or material waste that goes back into Earth’s systems, often polluting them.

Economic models shape how we think about the interactions between groups of people and between humans and the natural world as we try to meet our needs. If we use economic models that leave out important aspects of our society and the natural world, we may ignore and harm them as our current economies often do, as is discussed in Section 1.1.3.

The embedded economy model shows a more complete and complex picture of our connection to the natural world and other human beings. This model can help us think more carefully about how we can design the economy to support society and nature, which is its purpose.

• Sketch the embedded economy model on a piece of paper and place each of the needs and wants listed in your table in the location of the model where it seems most appropriate.

• If you are working in pairs or a group, discuss why you placed certain needs and wants in certain positions.

• Are there any patterns, for example differences between where needs and wants are fulfilled? If so, why might that be?

Option 2: Comparing the circular flow and embedded economy diagrams

Below are the basic circular flow of income and the embedded economy models. Now that you have seen both models, it is a good time to compare them to see their uses and limitations and what it can tell us about the role and importance of models.

Consider the following questions, either alone, with a partner, or as a whole class:

• What does each model help us focus on? What is each model’s purpose?

• Who might be interested in each model and what might they value?

• What is left out of each model that might be important for new students in economics to know?

Ideas for longer activities, deeper engagement, and projects are listed in Subtopic 1.5 Taking action

• Nature: Our most precious asset - Video narrated by Cambridge University economics professor Sir Partha Dasgupta. In the video, he explains the role of nature in our lives and the importance of protecting it. Difficulty level: medium

• Models & Laws | How & How NOT to Do Economics with Robert Skidelsky - A video of economics professor Robert Skidelsky discussing how models are constructed and the role of assumptions in models. Difficulty level: high

EAT-Lancet Commission (2019). The Planetary Health Diet. https://eatforum.org/eat-lancet-commission/the-planetary-health-diet-and-you/.

Raworth, K. (2017). Doughnut economics: seven ways to think like a 21st century economist. London: Penguin Random House.

Reardon, J., Caporale, M. M. A., & Cato, M. S. (2018). Introducing a new economics: Pluralist, sustainable and Progressive. London: Pluto Press.

Link to Quizlet interactive flashcards and terminology games for Section 1.1.2 The embedded economy

model: simplified representations of our world used to communicate ideas, understand complex processes and make projections or predictions

projection: an estimate of a future situation based on present trends

economy: all the human-made systems that transfer and transform energy and matter to meet human needs and wants

transfer: to move something from one place to another

transform: a change in the state, energy or chemical nature of something

energy: the ability to do work or cause change

matter: anything that takes up space and has mass

economics: the study and practice of how we organise ourselves to meet human needs and wants in the planetary ‘household.

mental models: a way of representing reality within one's mind

circular flow of income model: a model showing the flow of money and resources or products back and forth between businesses and households and other economic agents in a cycle

market: a system where people buy and sell goods and services for a price.

good: tangible (you can feel and touch them) items used to meet human needs and wants

service: intangible (you cannot feel and touch them) activities used to meet human needs and wants

agent: a person or thing that takes action or produces some impact

stakeholder: a person who has an interest in or is impacted by some activity

household: a system where people living together care for each other and do domestic work, often termed the 'core economy'

labour: work to achieve some goal

wage: payment for work

profit: the difference between the amount earned from selling something and the costs of buying, operating, or producing it

income: money received from work or investments

embedded economy model: an economic model showing that the economy is shaped by society and dependent on nature

system: a set of interdependent parts that organise to create a functional whole

provisioning institution: a group of people and their relationships as they try to meet human needs and wants

ecosystem: the interaction of groups of organisms with each other and their physical environment

state: a system that provides essential public services, and also governs and regulates other economic institutions

commons: a system where people self-organise to co-produce and manage shared resources.

regulate: to control human activities with rules and regulations

embed: to fix something to something else

culture: the beliefs, values, attitudes, behaviours and traditions shared by a group of people and transmitted from one generation to the next

norm: a social rule for accepted and expected behaviour, can be stated or unstated

value: ideas about what is important or good

pollution: the presence of a substance that has harmful effects on the environment