Interdependence of major sectors, markets and flows in a mixed economy ECS 1601 Study Unit 1 Interdependence of major sectors, markets and flows in a mixed economy

If the slide has a red speech bubble that says READ section so-and-so, hit pause, read the section and watch the slide thereafter! Hi. My name is David, I am an economic student and I am going to help explain ECS 1601 to you. You can do it! Remember, the best way to learn is to take notes and ASK if you don’t understand.

Content In this study unit you will learn more about: Production, income and spending Interdependence of households and firms Introduction to the government Introduction to the foreign sector Introduction to the financial sector A summary of total production, income and spending

1.1. Production, income and spending Read sections 3.1 and 3.2 in textbook pp 40-42 and box 3.1 on p. 41 1.1. Production, income and spending Production Income Spending Let’s say David works in a firm that PRODUCES laptops. By working, David receives an INCOME. With this income, David goes to the shops and SPENDS it. He spends it on goods that were PRODUCED by all different producers.

1.1 Continued This simple diagram of production – income – spending shows the major flow in the economy. What is the difference between a flow variable and a stock variable? Flow variables are measured over time. Stock variables are measured at a specific time. Start a discussion with your e-tutor on the difference between stock and flow variables.

1.2 Sources of production: factors of production Read section 3.3 in textbook pp. 42-45 1.2 Sources of production: factors of production Four main factors of production: Sometimes a fifth factor is added: Natural resources Labour Capital Entrepreneurship Technology

1.2 Sources of production: factors of production Read section 3.3 in textbook pp. 42-45 1.2 Sources of production: factors of production Four main factors of production: Money is not a factor of production Money can be used to pay for factors of production but not to produce. To produce, it is necessary to employ factors of production. Natural resources Labour Capital Entrepreneurship

1.3 Sources of income: remuneration of factors of production Read section 3.4 in textbook pp. 45-46 1.3 Sources of income: remuneration of factors of production Different names for the income of production factors Natural resources Labour Capital Entrepreneurship Rent Wages and salaries Interest Profit

1.4 Sources of spending: the four spending entities Read section 3.5 in textbook pp. 46-49 and Box 3-4 1.4 Sources of spending: the four spending entities Four main spending entities: Households Firms Government Foreign sector

1.4 Sources of spending: the four spending entities Expenditure of households on goods and services is called consumption. We use the symbol C to depict consumption. Households C

1.4 Sources of spending: the four spending entities Firms are involved in production. To produce, they have to purchase capital goods such as machinery and equipment. We call this investment or capital formation and use the symbol I to depict this. Firms I

1.4 Sources of spending: the four spending entities The government purchases goods and services to provide certain services, such as health services, education, policing etc. Government expenditure is depicted using the symbol G. Government G

1.4 Sources of spending: the four spending entities Exports are goods that are produced in our country but sold to the rest of the world. It is depicted using the symbol X. Imports are produced in other countries but purchased to be used in our country. It is depicted using the symbol Z. Net exports, or net spending by the foreign sector on our production is thus X - Z Foreign sector X - Z

1.4 Sources of spending: the four spending entities Now we put it all together: Firms Government Households Foreign sector X - Z G I C Total spending = C + I + G + X - Z

1.4 Sources of spending: the four spending entities Read section 3.7 in textbook p0 50 - 53 1.4 Sources of spending: the four spending entities Households The household is a group of people that makes economic choices together. They consume goods and services to satisfy their wants and needs. In order to get money they have to sell the factors of production that they own. For example, dad and mom has to sell their labour to a firm,. meaning, they have to WORK.

1.4 Sources of spending: the four spending entities Firms A firm is an organisation that uses factors of production to produce goods and services. Households consume and firms produce. Firms are rational; they want to maximise profits Profit = revenue – cost

Goods and factor markets See Fig 3-3 on p 50 Goods and factor markets Firms produce goods and service Firms sell the goods and services to households on the goods market On the other hand… Households own factors of production They sell their factors of production to firms on the factor market Firms buy the factors of production so that they can produce goods and services Firms Goods market Households Factor Market Goods & services Factors of production Goods & services Factors of production

Circular flow of income & spending Let’s go the other way around… Firms spend on the factor market (to get the factors of production) This is how households get an income Households spend their income on goods and services From selling goods and services on the goods market, firms get an income Firms Goods market Households Factor Market Goods & services Factors of production Income Spending Goods & services Factors of production Spending Income See Fig 3-4 on p 51

Adding the government The government is all political officials on all levels, also known as the public sector. We use the letter G to depict government spending. Households and firms are rational; they make choices that are best for them! For example, David only buys things HE likes. But the government is supposed to make choices that helps the country obtain the national goals. The government should create a healthy environment for the economy to function in. The government also has an effect on the circular flow between households and firms: When government spends, it is an injection into the spending-income flow. But taxes are a leakage out of the spending-income flow. Make sure to discuss this with your e-tutor.

Let’s put the two figures together. Now, let’s add the government (G) Spending Firms Goods market Households Factor Market Goods & services Factors of production Income See Fig 3-5 on p 51 Government buys labour, capital and other factors of production on the factor market. Thus, the government is also an employer The G also buys goods and services from the goods market. Thus, the G is a special type of consumer. They buy cars for transport, food for functions, building material for RDP houses, etc. Public goods and services TAXES G gives public goods and services to firms. For example, firms deliver goods via public roads. Income G gives public goods and services to households. For example, police protect citizens from crime Let’s put the two figures together. Now, let’s add the government (G) Government Spending Government Spending Firms pay taxes Labour, capital, etc Goods & services Households pay taxes Public goods and services TAXES

Adding the foreign sector The foreign sector is all the other countries in the world. South Africa is an open economy due to our strong links with the rest of the world. The balance of payments summarises all the flows (such as trade) between South Africa and other countries. Imports (Z for short) is goods and services that are produced in other countries and sold in South Africa. Similar to taxes, Imports is also a leakage out of the income-spending flow of an economy. Exports (X for short) is the goods and services that are produced in South Africa but is sold in other countries. Exports (like government spending) is a injection into the income-spending flow of an economy. See figure 3-6 on page 52.

Financial sector Financial institutions are the middle man between those who want to save 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 lend to someone else, like a firm, that firm will buy capital goods such as machinery. We call that a capital formation and that is a form of investment (I). Investments are injections into the circular flow of income and spending. See figure 3-7 page 52.

Summary You now know more about: Production, income and spending Aggregate (meaning TOTAL) spending in South Africa consists of C+I+G+X-Z C for Consumption (what ALL the 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 African spending on foreign goods) Taxes, savings and imports are leakages from the circular flow of income and spending. Government spending, investment and exports are injections into the circular flow of income and spending.

Are you able to: Identify the three major flows in the economy? Distinguish between a flow and a stock variable? Identify the two basic sets of markets in the economy? Identify the various economic participants? Identify the various injections and leakages from the circular flow of income and spending? Can you draw a diagram that shows the flow of goods and services between households and firms? Can you draw a diagram that shows the interaction between different sectors in the economy by means of the circular flow of income and spending?

Well done! Keep it up. That is the end of study unit 1. A quiz on this work will be available soon; make sure you do it and discuss it with your e-tutor!