LEARNING UNIT 1

INTERDEPENDENCE BETWEEN MAJOR SECTORS, MARKETS AND FLOWS IN A MIXED ECONOMY

1. INTRODUCTION
 Distinguish between microeconomics and macroeconomics and give some examples of each.
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 Explain what is meant by interdependence in an economic system.

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2. PRODUCTION, INCOME AND SPENDING

- Production creates income for the fop and then part or all of this income is spent to purchase the available g and s
- There is a continuous circular flow of production, income and spending in the economy
 Draw a simple circular flow diagram to illustrate the 3 major flows in the economy.

 Define a stock and give examples.

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 Define a flow and give examples.

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NB: Production income and spending are all flows

- The 4 main participants in the economy are firms, households, govt and foreign sector.
- The 3 basic activities in any economy are production, exchange and consumption.
- Exchange occurs in markets and links the various sectors.
- The 2 main sets of markets are the Factor market and the goods market.

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3. SOURCES OF SPENDING: THE FOUR SPENDING GROUPS

 Households
- Are the basic decision-making unit in the economy
- Members of households are referred to as consumers as they consume g and s to satisfy wants
- Own most of the fop which they sell in the factor market to firms in return for income in the
form of rent, salaries/wages, interest and profit.
- Use this income to purchase consumer g and s in the goods market
- Total spending by households on consumer g and s is called total consumption which is
represented by C
- Always try to maximise satisfaction given available means, ie. they are rational

 Firms
 Define a firm.
Organisation that employs factors of production to produce goods and services that are sold in the goods market.
- Are the basic productive unit in an economy
- They convert fop into g and s
- Buy fop from households in the factor market, transform them into g and s and sell them in the
Goods market
- Also rational as they always aim to maximise profit
- The purchase of capital goods by firms is known as investment or capital formation which is
represented by I

 Draw the circular flow of goods and services and factors of production between households and firms.

 Draw the circular flow of income and spending.

- The flow of g and s is a real flow while the flow of income and spending is a monetary flow
- The two flows are in opposite directions

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 Government
- Refers to local, regional (provincial) and national government
- Main function is to establish framework within which the economy operates
- Purchases fop from households in factor market and g and s from firms in goods market
- Provides households and firms with public g and s such as defence, law and order, health etc. which are financed
mainly by levying taxes.
- Also transfers some of tax revenue directly to needy people
 Name the 3 main flows associated with government activity.
Govt expenditure, taxes and transfer payments
- Taxes are a leakage or withdrawal from the flow of spending and income between households and firms
- Transfer payments do not directly affect the overall size of the flows
 Draw a circular flow diagram that includes government.

 Foreign sector
- Consists of all countries and institutions outside the country’s borders
 Explain the meaning of an open economy.
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- The balance of payments is an account that records the various flows between SA and the rest of the world
 Explain the meaning of globalisation.
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- Exports (X) are goods that are produced within the country but are sold to the rest of the world
- Imports (Z) are produced in the rest of the world but are purchased in the domestic economy
- Exports are an injection into the circular flow of income and spending in the domestic economy
- Imports are a leakage from the flow

 Draw a circular flow diagram that includes the foreign sector.

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  Total spending
- Also known as aggregate expenditure
- Total spending on SA g and s consists of
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ie. total expenditure = C + I + G + X - Z

 Financial sector
- Includes banks, insurance companies, pension funds and the JSE
- Acts as a link or intermediary between households or firms with surplus funds (surplus units) and other
participants that require funds (deficit units)
- Not directly involved in production of goods
- Surplus units spend less than they earn and can save some of their income
- Savings is the act of not consuming and is represented by S
- Savings is a leakage from the circular flow and is channelled to financial institutions
- Deficit units spend in excess of their income and require funds so they need to borrow
- Financial sector lends funds to firms wanting to borrow to expand productive capacity by purchasing
Capital goods
- Investment (I) represents an injection into the circular flow
 Draw a diagram showing the circular flow of income and spending between households, firms and the financial
sector.

Mohr, P & Associates. 2014. Economics for South African Students. 5th ed. Pretoria: Van Schaik Publishers, pp 39 - 54
Mohr, P & Associates. 2020. Economics for South African Students. 6th ed. Pretoria: Van Schaik Publishers, pp 51 – 65

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