Economics Ch 3
Ch 3 – Production, income, and spending in the
mixed economy
3.1 Introduction
When you are studying microeconomics, you are studying small parts of the economy
by putting them under a microscope.
When you are studying macroeconomics, you are dealing with the economy as a whole.
Therefore we have to imagine things, we have to have mental pictures about how the
economy fits together. We use diagrams to set out the most important interrelationships
between the major components of the economic system.
In this chapter, we look at how all things fit together in a mixed economy. We start by
looking at the 3 major flows in an economy as a whole: production, income and
spending. These three flows and their interdependence form the cornerstone of the
study of macroeconomics.
3.2 Production, income and spending
Production creates income and this income is spent to purchase products. There is a
continuous circular flow of production, income and spending in
the economy.
One aspect of the economic problem that is not addressed in
the simple diagram is the distribution of the income amongst
participants.
Production, incomes and spending are all flows. To understand
this, we need to understand the difference between stocks(measured at a particular
point in time) and flows(measured over a period).
Stocks can only change as a result of flows. For example, Prices are ratios between
different flows.
Apart from production, income and spending, another important economic activity is
exchange. In a mixed economy exchanges usually take place in a market.
Stocks Flow
Measured in a specific moment – still Measured over a period of time – moving
pictures pictures
Examples: Examples:
Wealth Income
Assets Profit
Liabilities Loss
Capital Investment
Population Number of births and deaths
Balance in a savings account Demand for labour
Unemployment
1
, Economics Ch 3
3.3 Sources of Production: the production factors
Land and labour are sometimes referred to as primary factors of production. The rest
listed below are secondary factors of production.
Natural resources / land
All the gifts of nature. They are fixed in supply and the availability cannot be
increased.Both the quantity and the quality is important when looking at a natural
resource.
Labour
Defined as the exercise of human mental and physical effort in the production of goods
and services.
The quality of labour is more important than the quantity of labour, the quality is usually
described as human capital, which refers to the skills, knowledge and health of the
workers.
SPECIALISATION AND THE DIVISION OF LABOUR
Specialisation refers to the tendency of people, businesses and countries to concentrate
on different activities to which they are best suited.
Division of labour refers to the act of assigning individual workers to different tasks to
form part of a production process.
Advantages of the division of labour:
- It saves time
- Enables workers to be allocated to tasks they are best suited for
- Enables workers to develop specific skills
- It makes mechanisation/ automation possible
- It leads to better quality
Capital
Comprises all manufactured resources which are used in the production of other goods
and services.
Entrepreneurship
The entrepreneur is the driving force behind production. In some countries where
entrepreneurship is lacking, the government is forced to act as entrepreneurs to
stimulate economic development.
Technology
When knowledge is discovered and put into practise, more goods and services can be
produced. If this happens we say technology has improved. The discovery of new
knowledge is called invention while innovation is the incorporation of this knowledge
into actual production techniques and products.
Money is NOT a factor of production
2
Ch 3 – Production, income, and spending in the
mixed economy
3.1 Introduction
When you are studying microeconomics, you are studying small parts of the economy
by putting them under a microscope.
When you are studying macroeconomics, you are dealing with the economy as a whole.
Therefore we have to imagine things, we have to have mental pictures about how the
economy fits together. We use diagrams to set out the most important interrelationships
between the major components of the economic system.
In this chapter, we look at how all things fit together in a mixed economy. We start by
looking at the 3 major flows in an economy as a whole: production, income and
spending. These three flows and their interdependence form the cornerstone of the
study of macroeconomics.
3.2 Production, income and spending
Production creates income and this income is spent to purchase products. There is a
continuous circular flow of production, income and spending in
the economy.
One aspect of the economic problem that is not addressed in
the simple diagram is the distribution of the income amongst
participants.
Production, incomes and spending are all flows. To understand
this, we need to understand the difference between stocks(measured at a particular
point in time) and flows(measured over a period).
Stocks can only change as a result of flows. For example, Prices are ratios between
different flows.
Apart from production, income and spending, another important economic activity is
exchange. In a mixed economy exchanges usually take place in a market.
Stocks Flow
Measured in a specific moment – still Measured over a period of time – moving
pictures pictures
Examples: Examples:
Wealth Income
Assets Profit
Liabilities Loss
Capital Investment
Population Number of births and deaths
Balance in a savings account Demand for labour
Unemployment
1
, Economics Ch 3
3.3 Sources of Production: the production factors
Land and labour are sometimes referred to as primary factors of production. The rest
listed below are secondary factors of production.
Natural resources / land
All the gifts of nature. They are fixed in supply and the availability cannot be
increased.Both the quantity and the quality is important when looking at a natural
resource.
Labour
Defined as the exercise of human mental and physical effort in the production of goods
and services.
The quality of labour is more important than the quantity of labour, the quality is usually
described as human capital, which refers to the skills, knowledge and health of the
workers.
SPECIALISATION AND THE DIVISION OF LABOUR
Specialisation refers to the tendency of people, businesses and countries to concentrate
on different activities to which they are best suited.
Division of labour refers to the act of assigning individual workers to different tasks to
form part of a production process.
Advantages of the division of labour:
- It saves time
- Enables workers to be allocated to tasks they are best suited for
- Enables workers to develop specific skills
- It makes mechanisation/ automation possible
- It leads to better quality
Capital
Comprises all manufactured resources which are used in the production of other goods
and services.
Entrepreneurship
The entrepreneur is the driving force behind production. In some countries where
entrepreneurship is lacking, the government is forced to act as entrepreneurs to
stimulate economic development.
Technology
When knowledge is discovered and put into practise, more goods and services can be
produced. If this happens we say technology has improved. The discovery of new
knowledge is called invention while innovation is the incorporation of this knowledge
into actual production techniques and products.
Money is NOT a factor of production
2
