LO 1 AS 1: CIRCULAR FLOW OF INCOME AND NATIONAL ACCOUNTS

The main participants in a modern economy are:

Households
Firms
Governments
Foreign Sector
We will also look at the main markets and flows, and show how they are all related:
Markets for goods and services
Factor markets
Financial markets
Flows of production (real flows), income and spending (money flows)

1.1

Production, Income and Spending

The economic process is as follows:

Households own the factors of production
Firms use factors of production (scarce resources) to produce goods and services
Firms pay income (returns on factors of production) to the households for the
factors of production
Households use the income to spend on goods and services.
The participants of a modern mixed economy are households, firms, government and
the foreign sector. They all spend and, therefore, they all earn an income. Exchange is
the term economists use to explain what basically happens in the market place, either in
the goods and services market or the factor market.

1.2 The Interdependence Between Households and Firms

Main Participants (Simple model):

Households:
Households are defined by economists as people who live together and who make joint
decisions or are subject to the economic decisions of others. A household can consist of
an individual, family or married couple. Every person in the economy is deemed to be
part of a household. It is the household that is the basic decision making unit in an
economy. The members of the household are called consumers, since they engage in
the consumption of goods and/or services produced by the firms. All factors of
production are owned by individuals, who are members of households. The households
(individuals) sell their factors of production (for example labour) to the firms. They then
receive an income and use this to engage in consumption.
Firms:
Firms make the goods and services that consumers demand.

They do this by

employing or utilising the factors of production in a transformation process. Firms are

the productive units in an economy. Firms will decide how goods and services are
produced, via the pricing mechanism. A firm operates with the sole intention of realising
a profit.

Markets:
Goods: The goods market in macro-economics is a single market which represents
markets for all goods and services.
Factor: The scarce resources required by the firms to produce the goods and services
are purchased from the households on the factor markets. The incomes earned by the
owners of the factors of production are as follows:
Land / Natural Resources

Rent

Labour / Human Resources

Wages

Capital

Interest

Entrepreneurship

Profit

CIRCULAR FLOW OF PRODUCTION

The Circular Flow of Income and Spending

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3.3

Introducing the Government

This is includes national to regional and local. Also referred to the public sector" which
is a term used to indicate anything government owned. Naturally government also
participates in the circular flow of production, income and spending.

The government and foreign sector in the circular flow of income and spending

MEASURING THE PERFORMANCE OF THE ECONOMY

2.1

Macroeconomic Objectives

The following macroeconomic objectives are used to assess the performance of the
economy:

Economic Growth An increase in total production of goods and services. Not an

easy task, especially under the additional pressures of a rapidly growing
population.

Full Employment In the ideal situation a countrys resources (particularly

labour) should be fully utilised. In reality, the situation can be very different.
Unemployment leads to social problems.

Price Stability Keeping inflation under control (as low as possible). The SARB
has an inflation target of 3% - 6% per annum.

Balance of Payments Stability Ensuring that the balance of payments does not
run a prolonged deficit OR surplus

Equitable Distribution of Income This relates to a socially acceptable

distribution of income.