lOMoAR cPSD| 48680473
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Production, income and spending
Interdependence of Households and Firms
A household can be defined as all the people who live together and who make joint economic decisions or who
are subject to others who make such decisions for them e.g. an individual, a family or any group of people who
have a joint income and take decisions together etc.
They consume goods and services to satisfy their needs and wants. They receive income to satisfy their needs
and wants from the sale of their factors of production e.g. our parents have to sell their labour (work for a
company) to earn income.
Factors of production include labour, capital, Natural resources (land) and Entrepreneurship.
Members of households consume goods and services to satisfy their wants hence the name consumers.
This act of using or consuming products is called consumption.
The total or aggregate spending of all households on consumer goods and services is called total (aggregate)
consumption expenditure denoted as symbol C.
Flows are variables measured overtime e.g. income, loss, profits, number of births and deaths, investment, etc.
On the other hand, a stock is measured on a specific time e.g. wealth, assets, liabilities, population,
unemployment, etc.
The logical sequence is therefore as follows; Production creates income (earned in the production process by the
various factors of production) and this income is then spent to purchase the products.
We therefore assume that all income earned is spent on goods and services. In other words, there is a continuous
circular flow of production, income and spending in an economy.
The Major Flows in the Economy
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Financial Sector
Financial institutions are the intermediaries between those who want to some and those who want to borrow.
When someone saves money, it means they do not spend it in that month. So saving can also be seen as a
leakage from the circular flow of income and spending.
However, when the savings is borrowed to someone else like a firm, that firm will buy capital goods such as
machinery. We call that capital formation and that is a form of investment (I).
Investments are injections into the circular flow of income and spending.
Aggregate (Total) spending in an economy like South Africa consists of C + I + G + X - Z
C for consumption (what all households spend)
I for investment (what all the firms spend)
G for government Expenditure
X for exports (Foreign countries spending on South African goods)
Z for imports (South Africa spending on foreign goods)
Firms
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A firm is an organization that uses factors of production to supply or produce goods and services.
Households consume and firms produce.
Firms are rational in the sense that, they want to maximize profits as well as households because they want to
maximize satisfaction or utility.
Profits are obtained by getting a difference between revenue (P x Q) and costs (C x Q).
Therefore Profits = Revenue - Costs
Goods and factor markets
Firms produce goods and services
Firms sell these goods and services to households in the goods market.
On the other hand, households’ own factors of production and they sell these factors of production to firms in
the factor or resources market.
The firms buy these factors of production so that they can produce goods and services.
Firms spend in the factor market so that households can get an income.
Households spend this income on goods and services. After selling these goods and services, firms get income.
It is this income that firms use to produce more goods and services.
Foreign Sector
The foreign sector means the other countries in the world.
South Africa is an open economy due to the strong links (export and imports) with the rest of the world.
The balance of payments records all the flows between South Africa and other countries especially through
trade.
Imports (Z) are goods and services that are produced in other countries and sold in South Africa. Imports just
like taxes are a leakage out of income - spending flow of an economy.
Exports (X) are the goods and services that are produced in South Africa but sold in other countries.
Exports just like government spending are an injection into the income - spending flow of an economy
Introducing the Government
The government is all political officials at all levels. Also known as the public sector denoted as letter G.
Households and firms are rational because, they make choices that are best for them e.g. by buying things that
they only like.
Downloaded by Vincent kyalo ()
Downloaded by Vincent kyalo ()
, lOMoAR cPSD| 48680473
Production, income and spending
Interdependence of Households and Firms
A household can be defined as all the people who live together and who make joint economic decisions or who
are subject to others who make such decisions for them e.g. an individual, a family or any group of people who
have a joint income and take decisions together etc.
They consume goods and services to satisfy their needs and wants. They receive income to satisfy their needs
and wants from the sale of their factors of production e.g. our parents have to sell their labour (work for a
company) to earn income.
Factors of production include labour, capital, Natural resources (land) and Entrepreneurship.
Members of households consume goods and services to satisfy their wants hence the name consumers.
This act of using or consuming products is called consumption.
The total or aggregate spending of all households on consumer goods and services is called total (aggregate)
consumption expenditure denoted as symbol C.
Flows are variables measured overtime e.g. income, loss, profits, number of births and deaths, investment, etc.
On the other hand, a stock is measured on a specific time e.g. wealth, assets, liabilities, population,
unemployment, etc.
The logical sequence is therefore as follows; Production creates income (earned in the production process by the
various factors of production) and this income is then spent to purchase the products.
We therefore assume that all income earned is spent on goods and services. In other words, there is a continuous
circular flow of production, income and spending in an economy.
The Major Flows in the Economy
Downloaded by Vincent kyalo ()
, lOMoAR cPSD| 48680473
Financial Sector
Financial institutions are the intermediaries between those who want to some and those who want to borrow.
When someone saves money, it means they do not spend it in that month. So saving can also be seen as a
leakage from the circular flow of income and spending.
However, when the savings is borrowed to someone else like a firm, that firm will buy capital goods such as
machinery. We call that capital formation and that is a form of investment (I).
Investments are injections into the circular flow of income and spending.
Aggregate (Total) spending in an economy like South Africa consists of C + I + G + X - Z
C for consumption (what all households spend)
I for investment (what all the firms spend)
G for government Expenditure
X for exports (Foreign countries spending on South African goods)
Z for imports (South Africa spending on foreign goods)
Firms
Downloaded by Vincent kyalo ()
, lOMoAR cPSD| 48680473
A firm is an organization that uses factors of production to supply or produce goods and services.
Households consume and firms produce.
Firms are rational in the sense that, they want to maximize profits as well as households because they want to
maximize satisfaction or utility.
Profits are obtained by getting a difference between revenue (P x Q) and costs (C x Q).
Therefore Profits = Revenue - Costs
Goods and factor markets
Firms produce goods and services
Firms sell these goods and services to households in the goods market.
On the other hand, households’ own factors of production and they sell these factors of production to firms in
the factor or resources market.
The firms buy these factors of production so that they can produce goods and services.
Firms spend in the factor market so that households can get an income.
Households spend this income on goods and services. After selling these goods and services, firms get income.
It is this income that firms use to produce more goods and services.
Foreign Sector
The foreign sector means the other countries in the world.
South Africa is an open economy due to the strong links (export and imports) with the rest of the world.
The balance of payments records all the flows between South Africa and other countries especially through
trade.
Imports (Z) are goods and services that are produced in other countries and sold in South Africa. Imports just
like taxes are a leakage out of income - spending flow of an economy.
Exports (X) are the goods and services that are produced in South Africa but sold in other countries.
Exports just like government spending are an injection into the income - spending flow of an economy
Introducing the Government
The government is all political officials at all levels. Also known as the public sector denoted as letter G.
Households and firms are rational because, they make choices that are best for them e.g. by buying things that
they only like.
Downloaded by Vincent kyalo ()
