ECS1601 LATEST
SUMMARY.
Study Unit 1
Chapter 3 page 41
Interdependence of the major sectors, markets and flows in a mixed economy
3.1 Production, income and spending
The three major flows in the economy as a whole:
Production
Income
Spending
Production occurs, creates income; and all or p...
Study Unit 1
Chapter 3 page 41
Interdependence of the major sectors, markets and flows in a mixed economy
3.1 Production, income and spending
The three major flows in the economy as a whole:
Production
Income
Spending
Production occurs, creates income; and all or part of the income is spent to buy goods and services.
Flows
Production, income and spending are all flows. They are measured over a period of time. This period
must be specified. These are moving pictures of the economy.
Stocks
These are measured at a particular point in time. These are still pictures of the economy. Stocks can
only change as a result of flows. Capital stock can only increase if investment is made.
Apart from production, income, and spending, the other important econom ic activity that links the
various sectors in the economy is exchange. In a mixed economy, exch ange usually occurs in
markets. Goods, services and factors of production are all exchanged in markets.
Stock: still picture Flow: moving picture
Wealth Income
Assets Profit
Liabilities Loss
Capital Investment
Population Number of births and deaths
Balance in savings account Saving: diff between income & spending
Unemployment Demand for labor
Gold reserves held by the Reserve Bank Gold sales, production
Consumption
3.2 The interdependence between households and firms
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Although households own the factors of production, these factors cannot satisfy human wants
directly. Households sell their factors of production on the factor market to the firms who combine
these factors and convert them into goods and services. In return for the factors of production they
supply, households receive income in the form of wages, salaries, rent, interest and profit. This
income is then used to purchase consumer goods and services in the goods market, which satisfy
their wants.
Households
In economic analysis it is assumed that households are rational and attempt to maximise their
satisfaction given the means at their disposal.
The household is the basic decision-making unit in the economy.
The word “economics” is derived from a Greek word meaning the management of the household.
Members of household consume goods and services to satisfy their wants: consumers, and the act
of consuming is called consumption.
C = total consumption
Firms
This is the unit that employs factors of production to produce goods and services that are sold on
the goods market.
Firms are the basic productive units in the economy.
Firms are actually artificial units: they are ultimately owned by or operated for the benefit of one or
more individuals.
Firms are engaged primarily in production.
We assume that firms like households, are rational and aim to achieve maximum profit.
One of the factors of production firms purchase is capital and the act of purchasing is called
investment or capital formation = I.
3.3 Introducing the Government
In contrast to households and firms, who are assumed to act rationally and consistently, we do not
assume that government always acts in a consistent fashion.
Government’s economic activity involves 3 important flows:
1. Government expenditure: on goods and services including factor services = G
2. Taxes levied on and paid by household and firms = T
3. Transfer payments: the transfer of income from certain individuals a nd groups e.g. the
wealthy to other individuals and groups e.g. the poor.
Unlike government spending and taxation, transfer payments do not directly affect the overall size of
the production, income and expenditure flows. We only focus on Government spending G and Taxes
T.
Government spending constitutes an injection into the flow.
Taxes are a leakage or withdrawal from the circular flow.
3.4 Introducing the Foreign Sector
The fourth major sector is the foreign sector. An open economy is one that has strong links with the
rest of the world.
The various flows between South Africa and the rest of the world are summarized in the balance of
payments.
Globalisation occurs when the economic links between different countries beco me stronger and
more complex.
The flow of goods and services between the domestic economy and the foreign sector are:
Exports: additions or injections into the domestic economy = X
Imports: leakage or withdrawal from the domestic economy = Z
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3.5 Introducing the Financial Institutions
This sector serves as a link between those who save and those who require finance for investment
spending.
Households and firms that do not spend all their income during any particular period save some of
their income. Saving = S
To save is a decision not to consume. When saving occurs there is a leakage or withdrawal from the
circular flow. Saving is channeled to financial institutions.
These funds are then available to firms that wish to borrow to expand their productive capacity i.e.
deficit units.
When firms purchase capital goods, this is called investment = I. This results in an addition or
injection into the circular flow.
Saving is a withdrawal or leakage.
Investment is an addition or injection.
3.6 Total production, income and spending: a summary
Total spending = aggregate expenditure
Aggregate spending on South African goods and services consists of spending in the four sectors:
1. Spending by households on consumer goods = C
2. Spending by firms on capital goods = I
3. Spending by government on goods & services = G
4. Spending by foreigners on SA goods & services = X minusspending by SA on imported
goods and services = Z
Total expenditure = C + I + G + X – Z
Apart from these elements of total spending we have 2 other fl ows, which are leakages or
withdrawals:
1. Taxes which are paid to government = T
2. Saving which is income not spent = S
Study Unit 2
Chapter 15 page 313
The Monetary Sector
Money is anything that is generally accepted as payment for goods a nd services or is accepted in
settlement of debt.
15.1 Functions of money
Money as a medium of exchange
In a barter economy, a double coincidence of wants is necessary in order for the exchange of 2
goods to take place.
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