Exam (elaborations)
Exam (elaborations) Economics Ecs1601 (ECS1601)
- Course
- Economics Ecs1601 (ECS1601)
- Institution
- University Of South Africa (Unisa)
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, INTERDEPENDENCE OF THE MAJOR SECTORS, MARKET AND FLOWS IN AMIXED ECONOMY
➔ Production is not pursued for its own benefit, the ultimate aim is to use or
consume the products to satisfy human wants.
➔ Production creates income and this income is then spent to purchase products.
Production, Income and Spending
The Three major ’Flows’ in the economy
1. Production – Production occurs and thus, generates income
2. Income – Income is earned as a result of production
3. Spending – The income earned is spent to buy the available goods and
services
Although this version of the circular flow is simple, it teaches us four key insights that remain true
(albeit in slightly refined forms) in more sophisticated versions as well.
1. Spending = production. The total value of all spending by households becomes an inflow
into the firm sector and thus ends up on the revenue side of a firm’s balance sheet. The
revenues received by firms provide us with a measure of the total value of production in an
economy.
2. Production = payments to inputs. Flows in and out of the firm sector must balance.
The revenues received by firms are ultimately paid out to households.
3. Payments to inputs = income. Firms are legal entities, not people. We may talk in
common speech of a firm “making money,” but any income generated by a firm must
ultimately end up in the hands of real people—that is, in the household sector of an
economy. The total value of the goods produced by firms becomes an outflow of dollars
from the firm sector. These dollars end up in the hands of households in the form of income.
(This ownership is achieved through many forms, ranging from firms that are owned and
operated by individuals to giant corporations whose ownership is determined by stock
holdings. Not all households own firms in this way, but in macroeconomics it is sufficient to
think about the average household that does own stock in firms.)
4. Income = spending. We complete the circle by looking at the household sector. The
dollars that flow into the household sector are the income of that sector. They must equal
the dollars that flow out of the household sector—its spending.
A Flow and A Stock
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