economics chapter 3

Production, Income, and Spending in the Mixed Economy

• The economy has three major flows: production, income, and spending, which are interconnected and simultaneous.
• Stocks vs. Flows: Stocks are measured at a point in time, while flows are measured over a period of time.

Sources of Production: The Factors of Production

• Natural resources (land) are all gifts of nature, including farming and building land, forests, mineral deposits, fisheries, rivers, lakes, sunlight, rain, and seeds.
• Labour-intensive production emphasizes human effort, while capital-intensive production dominates with machines.
• Specialisation and the division of labour lead to increased productivity.

Sources of Income: The Remuneration of the Factors of Production

• Incomes are earned by selling the services of the factors of production.
• Remuneration for natural resources (land) is rent.
• Remuneration earned by labour is wages.
• Remuneration earned by capital is interest.
• Remuneration earned by entrepreneurship is profit.

Sources of Spending: Households and Firms

• Households supply services of labour to firms in the factor market and are the owners of factors of production.
• Households buy goods and services from firms in the goods market, with total spending known as Aggregate Consumption (C).
• Firms are buyers of factors of production in the factor market and sellers of goods and services in the goods market, aiming to maximise profits.
• Firms purchase capital, known as Investment or capital formation, denoted by the symbol I.

The Circular Flow of Goods and Services

• The circular flow diagram shows the interrelationship between households and firms.
• Households sell their factors of production to firms in the factor market, and firms transform them into goods and services sold to households in the goods market.

The Circular Flow of Income and Spending (Monetary Flow)

• Goods market: Households demand goods and services from firms and provide firms with money, while firms spend on factors of production.
• Factor market: Firms demand services of labour from households and households supply it in exchange for money from firms.
• Each market is described by the nature of the good and the geographic area.

The Foreign Sector in the Circular Flow of Income and Spending

• The foreign sector involves spending by foreigners on South African goods and services (X) minus spending by South Africans on imported goods and services (Z).

Financial Sector

• Financial institutions include banks, insurance companies, pension funds, and the JSE Securities Exchange.
• Financial institutions act as a link between surplus units (households or firms) and deficit units, facilitating saving and borrowing.

Total (Aggregate) Spending

• Total expenditure is the sum of household spending on consumer goods and services (C), firm spending on capital goods (I), government spending on goods and services (G), and foreign spending on South African goods and services (X) minus spending by South Africans on imported goods and services (Z).

Leakages and Injections

• Government public spending on goods and services (G) is an injection, while taxes (T) are a leakage.
• Savings (S) are a leakage, and investment spending (I) is an injection.
• Total planned injections equal total planned leakages.

The Major Elements of the Circular Flow of Income and Spending

• The diagram summarises the essence of the previous circular flow diagrams, highlighting the flow between households and firms, and the leakages and injections into the circular flow.