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CHAPTER 3 – INTERDEPENDENCE BETWEEN MAJOR SECTORS, MARKETS
AND FLOWS IN THE MIXED ECONOMY
STUDY UNIT 1
Production, Income and Spending
*Identify the three major flows in the economy
Production – occurs and generates income
Income - earned
Spending – Buy available goods and services
*Distinguish between a flow and a stock
(Box 3-1 Stocks and Flows)
STOCKS FLOWS
• Measured at a particular point in time • Has a Time dimension – only
• NO time dimension measured over a period
• Water level of dam measured at a • Flow of water into the dam measured
particular point in time (at 00:00 on over a period (1 May 2007 inflow
May 1 2007 capacity was 72,64%) was measured as 250 cubic metres
per second
• Stock Takes • Calculation of sales, profit or loss
• Still pictures • Moving pictures
Examples Examples
• Wealth • Income
• Assets • Profit
• Liabilities • Loss
• Capital • Investment
• Population • Number of births and deaths
• Balance in savings account • Saving
• Unemployment • Demand for labour
• Gold reserves held by SA Res • Gold sales, gold production
bank
• Stocks and flows are related
• Stocks can only change as a result of flows
• Prices are ratios between different flows
• Ratios between a stock and flow and visa versa have a time dimension
• Ratios between two stocks and two flows have no time dimension
“Identify the two basic sets of markets in the economy
Goods Markets – Markets for goods and services
Factor Markets – Markets for factors of production
1
,Interdependence of households and firms
HOUSEHOLDS FIRMS
All people who live together and who Unit that employs factors of production to
make joint economic decisions or who produce goods and services that are sold
are subjected to others who make such on the goods market
decisions for them
• Every individual is a member of a • Firms purchase factors of production
household in the factor market
• Own factors of production • Transform factors into goods and
• Sell them on factors markets to firms services
• In exchange they receive income to • Sell these goods in the goods market
purchase consumer goods in the
goods market
• Goods then consumed to satisfy
human wants
• Members are called consumers – the • Capital purchased by firms – the act
act of consuming is consumption of purchasing capital goods is
investment or capital formation ( I )
• Total spending is called total or
aggregate consumption ( C )
CIRCULAR FLOW OF GOODS & CIRCULAR FLOW OF INCOME AND
SERVICES SPENDING
• Households sell their factors of • Firms purchase factors of production
production to firms in the factor in the factor market
market
• Firms transform factors into goods • Firms spending = income of the
and services households
• Sell product to household in the • Households spend income to
goods market purchase goods and services
• Household spending = income of
firms
2
,Circular flow of goods and services (Figure 3-2)
FIRMS
Factor Goods
Market Market
HOUSEHOLDS
Circular flow of income and spending (Figure 3-3)
Income
Spending
FIRMS
Factor Goods
Market Market
HOUSEHOLDS
Income Spending
(Wages, profit, etc)
3
, *Identify the various injections into leakages from the circular flow of income and
spending
Introducing the government
• Local, Regional and National (Public Sector)
• Primary function – establish framework within which the economy operates
• Purchases factors of production from households (factor market)
• Purchases goods and services from firms (goods market)
• Provides households and firms with public goods and services
• In return taxes are paid and households and firms
• Government’s economic activity involves 3 important flows
❖Government expenditure ( G )
❖Taxes ( T )
❖Transfer payments – e.g. wealthy to poor
• Government spending – injection into flow of spending and income
• Taxes – leakage or withdrawal from flow of income between households and
firms
The government in the circular flow of production, income and spending (Figure 3-4)
Labour, capital and other factors of Goods and services
production
FIRMS
Spending on factors Income (sales revenue)
of production
Public
goods
Taxes
and
Government Spending service
Government Spending
s
Factor Goods
Market GOVERNMENT
Labour, capital Goods Market
Public
goods
Taxes
and
services
Introducing the foreign sector
HOUSEHOLDS Consumer spending on goods
Income (wages, interest, etc.)
and services
Labour, capital and other factors of Goods and services
production
4
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