Lesson 2: The economic system and relevance to business and management

1. Economic needs

With a view to satisfying the needs expressed by all economic agents, the object of economics
will consist of identifying these needs, knowing their characteristics and even their evolution.

Definition: An economic need is a physical, mental, or intellectual sensation that

pushes the individual to make a physical or intellectual effort in order to obtain what is
necessary to put an end to this sensation.

Generally speaking, an economic need is the set of desires, aspirations of individuals (eating,
sleeping, housing, clothing, emancipation, education, drinking, etc.) which lead them to seek
goods likely to satisfy them (a good aims to satisfy a need; example: food = eat, water = drink,
clothing = clothe).

Characteristics of economics needs: an economic need has three (03) characteristics:

multiplicity (economic needs are numerous and even unlimited), satiability (the intensity of
the need decreases when is gradually satisfied) and interdependence (the different needs of an
individual are linked. Indeed, one good can be replaced by another to satisfy a same need: we
say that needs are substitutable. Likewise, to satisfy a need, the individual may be required to
first satisfy another need: we say that the needs are complementary (example: a car and fuel).

Classification of economic needs: economic needs are grouped into individual needs
[these are needs felt by each individual and the satisfaction of which ensures their survival
(eating, clothing, drinking, etc.). We distinguish between primary needs (these are the first
needs felt by any individual, for example: eating, drinking, sleeping) and secondary needs (these
are needs felt after the satisfaction of primary needs. These needs are generated by economic
and technical progress, for example: entertainment, travel, etc.) and collective needs (These are
the needs felt by an entire group or the entire society. These needs were born with the
development of group life and social activity. Although these needs are felt by the entire group,
their intensity can vary greatly from one individual to another. As collective needs, we can cite:
drinking water supply, construction of roads, bridges, sanitation, etc.).

Maslow's hierarchy of needs: All economic needs can be classified into 05 categories allowing
us to understand the motivations of individuals. Indeed, Abraham Maslow classifies needs
according to their degree of importance and believes that they are hierarchical. He represents
them in a pyramid as follows:

Figure 1: Maslow’s hierarchy of needs

Source: website Medium

Physiological needs can be: eating, sleeping, drinking, etc.

Safety needs: having health or life insurance, having savings, housing, etc.
Belonging needs: membership in a group or associations.
Esteem needs: having social status, prestige, reputation.
Self-actualization needs can be self-transcendence, the accomplishment of great works, and
research of a great personality.

The progression in the pyramid (from the base to the top) is done in stages. It assumes that the
needs of the lowest scale must first be satisfied before the individual aspires to satisfy those of
the next scale. But generally speaking, individuals first seek to satisfy their most pressing needs
(physiological needs according to Maslow), then they progress in the hierarchy.

2. Economic goods

To satisfy their needs, individuals consume goods that are the product of economic activity.

Definition: An economic good is a good or service that producer provides to meet the
needs and wants of consumer. It provides utility to the consumer. It’s an available wealth
existing in limited quantity and capable of satisfying a need.
 Characteristics of an economic good: An economic good mainly has 3 characteristics:
availability (individuals must be able to obtain the good at the desired time), scarcity (Goods
are often scarce compared to needs), ability to satisfy a need (If there is no need expressed by
individuals, there is no good in the economic sense. It is the need that gives utility to a good).

Classification of economic goods: 03 criteria make it possible to classify economic

goods. These are: physical reality, function or use, duration.
According to physical reality criterion, we distinguish between material / tangible goods
(table, bench, chair, car, pen, plantain, etc.) and immaterial / intangible goods or services
(insurance, transport, health, education, security, bank and financial services, catering, love,
etc.).

According to the criterion of function, we distinguish between consumer goods (they

are goods that can be directly used to satisfy needs. These are final goods. We can cite among
others: biscuits, medicines, the car, the condom, an armchair, a donut), intermediate goods
(they are goods included in the process of production or manufacturing of other goods. These
are the raw materials, the foodstuffs (example: wheat which is used in the production of bread,
biscuits) and production goods [are those that are used several times in the production process
of other goods (consumer goods or production goods). These are machines, kitchen utensils,
buildings, equipment, energy sources, etc.].

According to duration criterion, durable goods (goods which are destroyed very slowly
through use. Example: machines, buildings, etc.) are distinguished from non-durable goods
[they are goods that are destroyed upon first use. Example of food (non-durable consumer
goods), raw materials (intermediate goods or non-durable production goods)].

Different types of goods according to Engel: for economist Engel, there are three types
of goods: primary goods (These are goods for which demand increases less than in proportion
to the increase in consumer income. These are mainly food items), secondary goods (These
are goods for which demand increases in proportion to the increase in consumer income. These
are for example, housing, capital goods, clothing) and tertiary goods (These are goods for
which demand increases more than in proportion to the increase in income. Example of leisure).

Another classification leads to distinguishing direct goods (These are final consumption
goods, that is to say, capable of directly satisfying needs) from indirect goods (These are
production goods, that is to say goods which are used for the production of other goods).
 3. Actors of economic life / Economic actors

Like any social action, the economy requires the intervention of several actors. These are the
economic agents also called “institutional units” in the context of national accounting. These
actors are very numerous and they are generally grouped into 5 categories called “institutional
sectors”. Each institutional category or sector plays a specific and preponderant role in
economic activity. These include:

- Companies or producers: The specificity of this sector is the production of market

goods to satisfy needs. The main producers are businesses. Their activities are classified
into three sectors (primary, secondary, tertiary) called traditional production sectors
(Jean Fourastié and Colin Clark).
- Households or consumers: The main activity of households or consumers is the
consumption of goods or services to satisfy their needs. However, they offer companies
their labor force (production factor). Their resources consist of salary, various salaries,
state transfers, and income from their investments. The household is a set of individuals
or groups of people living together under the same roof and providing together for their
expenses (needs).
- State and administrations: Their main activity is the production of non-market
services (services that are not intended to be sold on a market). We distinguish between
public administrations and private administrations. Public administrations provide
public services whose financing is ensured by the community. These are central
administrations and their bodies (ministries, delegations, administrative services), local
public administrations (municipalities, town halls, regions) and social security
administrations (national social security fund – CNPS, etc.). The resources of public
administrations are taxes, customs duties, debt, mining resources, etc.
Private administrations, for their part, offer non-market services whose financing is
ensured by contributions from their members. We can cite unions, political parties,
associations, religions, etc. their resources consist of member contributions and state
subsidies.
- Financial institutions: Their main activity is financing the economy.
- Rest of the world: It is a fictive sector which brings together the different transactions
(flows) between the resident and non-resident sectors, that is to say transactions between
foreign actors who carry out exchanges with national actors.
 4. Economic flow / Circular flow diagram

Economic flow or circular flow diagram is an economic model that pictures the economy as
consisting of two groups—households and firms—that interact in two markets: the goods and
services market in which firms sell and households buy and the labor market in which
households sell labor to business firms or other employees.

Figure 2: The Circular Flow Diagram

The circular flow diagram presented in figure 2 shows how households and firms interact in the
goods and services market, and in the labor market. The direction of the arrows shows that in
the goods and services market, households receive goods and services and pay firms for them.
In the labor market, households provide labor and receive payment from firms through wages,
salaries, and benefits.

Firms produce and sell goods / services to households in the market for goods and services (or
product market). Households pay for goods and services, which becomes the revenues to firms.
Firms pay for the inputs (or resources) they use in the form of wages and other factor payments.

This version of the circular flow is stripped down to the essentials, but it has enough features
to explain how the product and labor markets work in the economy. We could easily add details
to this basic model if we wanted to introduce more real-world elements, like financial markets,
governments, and interactions with the rest of the globe (imports and exports).

NB: flows represent movements of goods and services (real flows) or movements of money
(monetary flows) between different institutional sectors. Each flow is characterized by its nature
and its direction which is conventionally represented by an arrow.
In general, flows are reciprocal. A real flow (work, good and service) corresponds in return to
a monetary flow (salary, consumption expenditure, tax).

5. How to organize economies: an overview of economic systems

There are at least three ways that societies organize an economy. The first is the traditional
economy, which is the oldest economic system and is used in parts of Asia, Africa, and South
America. Traditional economies organize their economic affairs the way they have always done
(i.e., tradition). Occupations stay in the family. Most families are farmers who grow the crops
using traditional methods. What you produce is what you consume. Because tradition drives
the way of life, there is little economic progress or development.

Command economies are very different. In a command economy, economic effort is devoted
to goals passed down from a ruler or ruling class. Ancient Egypt was a good example: a large
part of economic life was devoted to building pyramids, like those in Figure 1.7, for the
pharaohs. Medieval manor life is another example: the lord provided the land for growing crops
and protection in the event of war. In return, vassals provided labor and soldiers to do the lord’s
bidding. In the last century, communism emphasized command economies.

In a command economy, the government decides what goods and services will be produced and
what prices it will charge for them. The government decides what methods of production to use
and sets wages for workers. The government provides many necessities like healthcare and
education for free. Currently, Cuba and North Korea have command economies.

Although command economies have a very centralized structure for economic decisions,
market economies have a very decentralized structure. A market is an institution that brings
together buyers and sellers of goods or services, who may be either individuals or businesses.
In a market economy, decision-making is decentralized. Market economies are based on
private enterprise: the private individuals or groups of private individuals own and operate the
means of production (resources and businesses). Businesses supply goods and services based
on demand. (In a command economy, by contrast, the government owns resources and
businesses.) Supply of goods and services depends on what the demands. A person’s income is
based on his or her ability to convert resources (especially labor) into something that society
values. The more society values the person’s output, the higher the income. In this scenario,
market forces, not governments, determine economic decisions.
Most economies in the real world are mixed. They combine elements of command and market
(and even traditional) systems. The U.S. economy is positioned toward the market-oriented.
Many countries in Europe and Latin America, while primarily market-oriented, have a greater
degree of government involvement in economic decisions than the U.S. economy. China and
Russia, while over the past several decades have moved more in the direction of having a
market-oriented system, remain closer to the command economy. For more details you can
consult table 2 below (Source: Seneca website).
 6. How Business and Economics Work

A business’s success depends in part on the economic systems of the countries where it is
located and where it sells its products. A nation’s economic system is the combination of
policies, laws, and choices made by its government to establish the systems that determine what
goods and services are produced and how they are allocated.

Businesses and other organizations operate according to the economic systems of their home
countries. Today the world’s major economic systems fall into two broad categories: free
market, or capitalism; and planned economies, which include communism and socialism.
However, in reality every country uses a mixed market system that incorporates elements from
more than one economic system.

The major differentiator among economic systems is whether the government or individuals
decide:

- How to allocate limited resources—the factors of production—to individuals and

organizations to best satisfy unlimited societal needs?.
- What goods and services to produce and in what quantities?.
- How and by whom these goods and services are produced?.
- How to distribute goods and services to consumers?.

Managers must understand and adapt to the economic system or systems in which they operate.
Companies that do business internationally may discover that they must make changes in
production and selling methods to accommodate the economic system of other countries.