Understanding Basic Economic Activities and Models

Basic Economic Activities

• Production

  The use of economic resources to create goods and services to satisfy human wants.

• Consumption

  The use of goods and services by consumers through purchasing or in the production of other goods.

• Employment

  The use of economic resources in production; engagement in economic activity.

• Income Generation

  The maximum amount an individual can spend during a period without being any worse off.

Two Economic Units

• Household

  The basic consuming unit.

• Firm

  The basic producing unit.

Stock and Flow Variables

• Flow

  A quantity measured over a particular period of time.

• Stock

  A quantity measured at a given point in time.

The concepts of stock and flow measurements are essential in understanding the economic variables of wealth and income.

• Wealth

  Anything of value owned. It is a stock since it is what is owned at a particular time.

• Income

  The rate at which we earn money. It is a flow since income that is saved increases the stock of wealth.

Economic Model of Production

The Circular Flow of the Production Process

ECONOMIC RESOURCES → PRODUCING UNITS → GOODS AND SERVICES → HOUSEHOLDS

The Circular Flow of Income

INCOME FLOW OF WAGES, INTERESTS, RENTS → PRODUCING UNITS → PURCHASES OF GOODS AND SERVICES → HOUSEHOLDS

Implications of the Circular Flow

1. The flow of goods, resources, and money payments will continue as long as households continue to consume and firms continue to produce.
2. Since goods and resources flow in exchange for payments, the rate of payment flow will ultimately be the same. Money is the inducing factor and the pillar of the price system. Without it, there is no price system.

Inflows and Outflows

• Outflows (factors that decrease economic activity)
  • Savings
  • Taxes
  • Imports
• Inflows (factors that increase economic activity)
  • Investment
  • Government Spending
  • Exports

Three Sets of Policy

• Monetary Policy

  Affects savings and investment.

• Fiscal Policy

  Controls taxes and government expenditures.

• Trade Policy

  Affects a country's exports and imports.