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What is an economy?
Watch the video to discover how the factors of production work together to make a simple economy.
Like ‘The Matrix’ in the cult movie of the same name, the economy is all around us. Everything we do and want is part of the economy, and we are part of the economy. Our part of this simple economy is the household and we buy things as consumers of goods and services. Where do these goods and services come from? Where did you get the phone you are using right now? You didn’t make it, a business made it. Businesses are another part of this idea of the simple economy. Businesses buy ‘factors of production’ from households. Usually in the form of labour and some capital, based on savings.
In the simple economy, the place where you and I get the things we buy online or from shops and stores is known as the product market. Where businesses sell, and households buy, goods and services. This is what links consumers and businesses. It is the demand side of the simple economy. Businesses need the components and raw materials that they use to make the products we want to buy. They also need factors of production, such as; labour, machines in the form of capital, and land. Businesses buy these from the resource market, which is partly supplied by households. Remember, households consist of labour, they own land and provide capital from earnings, and value from entrepreneurship.
Businesses then produce goods and services through their links with households via the resource market. This is the supply side of the simple economy. So, what keeps the simple economy flowing? Money, which is the convenient form of exchange of value. Households earn money from wages by providing labour to businesses. They also buy products from businesses via the product market. This is known as consumption expenditure or spending. Businesses buy labour from households using wages and purchase resources from the resource market. They also sell the products they make in the product market, earning revenue. Goods and services flow from businesses via the product market to households. Factors of production flow from households to businesses via the resource market.
Money flows in one direction and things, products, flow in the other. Hence the exchange of value for goods. This is just the private sector. What is the role of government in this circular flow matrix? Governments provide goods and services that businesses do not want to provide, but the state deems necessary. Examples include logistics infrastructure, education, health, policing and defence. The government raises taxes from both businesses and households and uses the money to fund their government spending priorities. Money also flows from government in the form of business subsidies and welfare to some households.
The government is just like a business in that it will still need to obtain factors of production and many of its services and investments will be used by both businesses and households. So, there you are, a simple economy consisting of businesses and households, a product and resource market, all interacting in a circular motion with the help of money and the government.
For the factors of production to be utilised to their fullest potential, they need to be organised into an economy.
An economy consists of various markets, which are essentially a gathering of buyers and sellers. Economic markets are mechanisms used to allocate scarce resources in an economy. A country’s economy is a macroeconomic topic, but an economic market is a microeconomic mechanism that explains how the economy works.
An economy consists of consumers who buy products and services, businesses who employ consumers and make goods, and the government at various level who both buy products, employ labour and levy taxes. Their collective interactions create a simplified economy.
Watch the video above where Nick explains what a simple economy looks like.
An efficient economy allows easier movement of labour from households to firms, goods and services from firm to firm, and goods and services from firms to households. It also allows an easier movement of labour from one firm to another, and goods and services from firms to households.
Here’s the big link to logistics: Efficient transport and logistics is a key part of enabling scarce resources to be allocated easily and quickly based on factors relating to time and geographical location. Efficient logistics systems are therefore a key part of effective markets and economies.
Your task
Where do you and your employer fit into the economy outlined in the video?
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