ECONOMICS CHAPTER 3: DEFINITIONS

Production Creation of goods and services using inputs such as labor, capital, and
resources.
Income: Earnings received by individuals or businesses from the sale of goods,
services, or assets.
Spending: The use of money to purchase goods, services, or assets

Stock: Quantity of a good, asset, or resource held at a specific point in time.

Flow: Movement or transfer of goods, services, or money over a period of time.

Goods Market Market where goods and services are bought and sold by households and
firms.
Factor Market: Market where factors of production, such as labor and capital, are bought
and sold.
Factors of Resources used in the production process, including land, labor, capital, and
Production: entrepreneurship
Natural Materials or substances found in nature that are used in production, such as
Resources: minerals, water, and forests.
Labour: Human effort used in the production of goods and services.

Specialization Concentration of individuals or businesses on specific tasks or activities.

Division of Allocation of different tasks or roles to individuals or groups within a

Labour: production process.
Human Capital Knowledge, skills, and abilities possessed by individuals that contribute to
their productivity and earning potential.
Capital: Assets or resources used in production, such as machinery, equipment, and
buildings.
Consumption of Depreciation or wear and tear on capital goods used in production.
Fixed Capital:
Entrepreneurship Activity of organizing and managing resources to create new products,
services, or businesses.
Technology: Application of scientific knowledge and techniques to the production
process.
Money Medium of exchange and store of value widely accepted in transactions.

Capital Intensive Production process that relies heavily on capital goods relative to labor.
Production:
Labour Intensive Production process that relies heavily on labor relative to capital.
Production:
Rent: Payment for the use of land or other natural resources.

Wages and Payments to labor in exchange for work performed.

Salaries:
Interest Payment for the use of borrowed money or capital.

Profit Revenue remaining after deducting expenses from total income.

Households: Individuals or groups of people living together and consuming goods and
services.
Consumer Expenditure by households on goods and services.
Spending:
Firms: Business organizations that produce goods and services for sale.

Capital Process of increasing the stock of capital goods through investment.

Formation:
Government: Institution responsible for making and enforcing laws, providing public
goods and services, and managing the economy.
Public Sector Part of the economy controlled or owned by the government.

Taxes: Compulsory payments to the government by individuals and businesses.

Transfer Payments made by the government to individuals or groups without

Payments: receiving goods or services in return.
Foreign Sector: Part of the economy consisting of transactions with other countries.

Circular Flow: Model depicting the flow of goods, services, and money between
households, firms, and the government in an economy.
Injection: Addition of spending into the circular flow of income, such as investment,
government spending, or exports.
Leakage: Withdrawal of spending from the circular flow of income, such as saving,
taxes, or imports.
Financial Sector: Part of the economy that facilitates the allocation of capital and resources
through financial markets and institutions.
Absolute Ability of a country to produce a good or service more efficiently than
Advantage: another country.
Relative Ability of a country to produce a good or service at a lower opportunity
Advantage: cost than another good or service.
Macroeconomic Goals pursued by policymakers to achieve desired outcomes in the overall
Objectives: economy, such as stable prices, full employment, and economic growth.
 ECONOMICS CHAPTER 3:
CHAPTER 3: PRODUCTION, INCOME AND SPENDING IN THE MIXED ECONOMY

Chapter focus:
• Total production
• Income and spending
• Sources of production
• Sources of income
• Sources of spending
• Interdependence of the main sectors in the economy

3.1 Introduction
• Micro economy can be compared to a flea market with individual stalls and owners.
• Macro economy can be envisioned as something that cannot be touched or seen.
• When dealing with the economy you must imagine things, we must use mental
pictures.
• In an economic system everything does indeed depend on everything else.
• Three major flows in the economy as a whole: total production, total income, total
spending
• When we start to look at the economy we start at the households and firms, then we
construct a simple picture of how they are linked then we introduce the foreign sector.
The picture is completed by looking at the financial sector's impact on the economy.

3.2 PRODUCTION, INCOME, AND SPENDING

• The total production of goods and services is a major concern for economists.
• The aim is to use or consume the products to satisfy human wants.
• Production creates income and then income is spent to purchase products.
• Production occurs, income is earned, and the income is spent.
• An aspect of economics is how the income is distributed between various participants
of the economy.

PRODUCTION
N

SPENDING INCOME

• Production, income, and spending are all flows to understand wat this means we must
distinguish between:
 1. Stocks: which are measured at a particular point of time e.g., wealth, assets, capital
2. Flows: which are measured over a period (production, income, and spending) e.g.,
income, profit, investment
• In the mixed economy, the households, firms, the government, and the foreign sector
all participate in the production process.
• In a mixed economy exchange usually occurs in markets.
• There are two types of markets:
1. Goods market: the market for goods and services
2. Factor markets: the market for several factors of production.

3.3 SOURCES OF PRODUCTION: THE FACTORS OF PRODUCTION

• Primary factors: natural resources and labor
• Secondary factors: capital and entrepreneurship
• There can also be distinction between human resources (labor/entrepreneurship) and
non-human resources (natural/capital)

Natural resources:
• All the gifts of nature like mineral deposits, water, arable land, vegetation, natural
forests, marine resources, animal life, atmosphere, sunshine.
• Natural resources are fixed in supply, their availability cannot be increased if we want
more of them.
• Minerals are referred to as non-renewable or exhaustible assets.
• The quality and quantity of natural resources are important just like the other factors of
production.

Labor:
• Goods and services cannot be produced without human eYort.
• Labor can be defined as the exercise of human mental and physical eYort in the
production of goods and services.
• The quantity of labor depends on the size of the population and the portion that is
willing to work.
• The quality of labor is described as human capital which refers to the skills, knowledge,
and health of the workers.

Advantages of division of labor:

1. Saves time.
2. Workers can be allocated tasks that they are best suited for
3. Workers can develop specific skills.
 4. Mechanization – machines can work 24 hours a day.
5. Better quality production
Disadvantages of labor division:
1. Work can become monotonous and boring.
2. Worker alienation – the workers do not appreciate their part of the work.
3. Interdependence – if one person is slow the whole production process is slowed down.

Capital:
• Capital compromises all manufactured resources which are used in the production of
other goods and services.
• When we talk about capital as a factor of production, we do not talk about the financial
connotation we refer to the tangible things that are used to produce other things.
• To produce capital goods, current consumption must be sacrificed in favor of future
consumption.
• Capital goods do not have an unlimited life.
• Provision must be made for existing capital goods because they do not last forever, this
is called provision for depreciation, in national accounts it is referred to as
consumption of fixed capital.

Entrepreneurship:
• The availability of natural resources, labor, and capital means nothing without people
who see opportunities and can organize and combine these factors of production.
• The entrepreneur is the driving force behind production, they are the initiators, the
people who take initiative, innovators, risk takers.

Technology:
• Technology is sometimes identified as a 5th factor of production.
• The discovery of new knowledge is called invention while the incorporation of
knowledge into actual production is called innovation.

Money is not a factor of production:

• Money is important but it is not a factor of production.
• Goods and services cannot be produced with money, money is only a medium of
exchange.
• Monet facilitates the exchange of goods and services.
The choice of technique:
• When production is dominated by machines we talk about capital-intensive production
• When the emphasis is on labor, we call it labor-intensive.
• The appropriate choice of technique will depend on the availability and quality of
several factors of production as well as their relative cost.

3.4 SOURCES OF INCOME: THE REMUNERATION OF THE FACTORS OF PRODUCTION

• The only way the total income in the economy can be raised is by increasing
production.
• The economy at large can increase income by producing more.
• The remuneration of natural resources is called rent.
• The remuneration of labor is called wages and salaries.
• The remuneration of capital is called interest.
• The remuneration of entrepreneurship is called profit.
• Total income consists of rent, wages and salaries, interest, and profit.
• The value of total income is identically equal to the value of total production.

3.5 SOURCES OF SPENDING: THE FOUR SPENDING ENTITIES

1. Households
2. Firms
3. The government
4. Foreign sector
Households:
• People who live together and who make joint economic decisions or are subject to
others making decisions for them are called households.
• A household can consist of an individual, family or people who share an income; every
person in the economy belongs to a household.
• Households are the basic decision-making unit in the economy.
• Members of households consume goods and services to satisfy their wants
(consumers)
• The total spending of all households is called total/aggregate consumption expenditure
or total consumption (C)
• In a market economy it is households or consumers who determine what should be
produced
• In a mixed economy most of the factors of production are owned by households
• Although households own these factors of production these factors cannot satisfy
human wants directly
Firms:
• A firm can be defined as the unit or organization that employs factors of production to
produce goods and services that are sold in the goods market.
• Firms are the basics productive units in the economy.
• Firms are primarily engaged in production.
• Firms convert factors of production into goods and services.
• Firms are buyers in the factor market and sellers in the goods market.
• Firms are always rational this means they always aim to achieve maximum profit.
• Profit = revenue – costs
• One of the factors of production purchased by firms is capital, this is called an
investment or capital formation (I)

Diverse types of firms:

1. Individual (sole) proprietorships: the firm is owned by a single person who makes all the
decisions, receives the entire profits and is legally responsible for the debts of the firm.
2. Partnerships: are firms that do not require substantial amounts of financing but that need
specialized ability
3. Companies: in the eyes of the law the company's identity is separate from the owner’s
identity
A) Private company – maximum 50 members and the right to transfer shares is restricted
and is known by [(Pty) Ltd] which appears after its name.
B) Public company – may not have fewer than 7 shareholders, these companies wish to
raise capital, their shares are easily transferrable, many public companies are listed on
the JSE, they are called listed companies.
a) Multinational companies – these companies are foreign-owned but also operate in
South Africa
4. Close corporations: these companies must display the letters cc after its name these
companies can no longer be created.
5. Other forms: informal sectors like business that are not registered like spaza shops.

Goods market:
• We treat this market as if it were the only market for all goods and services in the
economy.

Factor market:
• Factors of production are purchased and sold in many diYerent markets.
• Labor markets and markets for capitals goods are included in the factor market
The government:
• Government/public sector is a broad term that includes all aspects of local, regional,
and national government.
• Government includes all politicians, civil servants, government agencies and other
bodies belonging to or under control of the government.
• The government does not always act in a consistent manner to obtain goals that vary
from time to time.
• Primary function of the government: establish the institutional framework within which
the economy operates, they also purchase factors of production from households as
well as goods and services from firms.
• In return the government provides households and firms with public goods and
services such as defense, law and order, education, health services, roads, and dams.
• These goods and services are paid for by die households and firms' taxes.
• Government expenditure: G
• Taxes: T
• Transfer payments: the transfer of income and expenditure from certain individuals and
groups to other individuals and groups.

The foreign sector:

• The South African economy is an open economy because we have always had strong
links with the rest of the world.
• Various flows between South Africa and the rest of the world are summarized in the
balance of payments.
• Globalization is the term used for when economic links between companies in the
world become stronger.
• The flows of goods and services between the domestic economy and the foreign sector
are exports (X) and imports (Z)

Total spending: a summary

• Spending by households on consumer goods and services: C
• Spending by firms on capital goods: I
• Spending by government on goods and services: G
• Spending by foreigners on South African goods and services minus spending by South
African on imported goods and services: X – Z
3.6 PUTTING THINGS TOGETHER: A SIMPLE DIAGRAM
Spending: C + I + G + X –Z

3.7 ILLUSTRATING INTERDEPENDENCE: CIRCULAR FLOWS OF PROCTION, INCOME AND

SPENDING
3.7 Few further key concepts
Specialisation and exchange:
• Production is characterized by specialization
• Each person specializes in certain production
• Specialization increases eYiciency and interdependence
• Transaction: Exchange involves the transfer of goods, services, or assets between parties
in return for something of value, such as money or other goods.
• Mutual Benefit: Exchanges occur because both parties believe they will benefit from the
transaction, either by obtaining something they value more or by fulfilling a need or want.
• Foundation of Markets: Exchange is the foundation of market economies
5 main macroeconomic objectives
1. Economic Growth
2. Full Employment
3. Price Stability
4. Income Distribution
5. Balance of Payments Equilibrium