The Operation of an Economy- 2. Distribution & Exchange of Goods & Services
In terms of distribution, it needs to strike a balance between providing rewards for investment, entrepreneurs and innovation, as well as ensuring everyone has an acceptable quality of life.
Gross Domestic Products (GDP): the monetary amount of goods and services produced in an economy of a given time. GDP also measures the total income of a society.
In a market economy, people earn income as a reward of their contribution to the production process. People do NOT receive the same wage level because income reflects on their skills, knowledge, qualifications, expertise and productivity.
Hence, this system of distribution encourages people to work harder and improve on their skills in order to gain a higher level of income.
However, this can be unfair to those who are unable to contribute to production due to illness, disability or age. They have less bargain power.
Government should help these group of people by taxing more from high income earners and redistribute it as social security payments to the low income earners.
In Australia, most people earn income from labour employment than from other sources (57%). But this gap has narrowed in recent years as the amount of income like rent and profit have increased substantially.
High income earners have higher disposable income and hence able to improve their living standards . They are able to save more and accumulate these to invest, which yields even greater returns.
In economics, it can be divided into 5 different sectors:
Individual Household Sector
Businesses Firm Sector
Financial Sector
Government Sector
Foreign Sector
1. Individual / Household Sector:
Households have economic resources like land, labour and capital which can be provided to businesses to produce goods and services. In return, they receive wages to purchase goods and services.
People pay Taxes (T) and should definitely Save (S) some money.
Hence, in the Circular Flow of Income, there are Leakages. Removing money from the circular flow of income.
2. Businesses Firm Sector: produce and distribute goods and services to consumers.
Businesses buy productive resources (i.e. land, labour, enterprise, capital) from the household sector and provide income (in the form of wages) to individuals.
Individuals will then purchase goods and services from firms.
3. Financial Sector (e.g. Banks, Financial Institutions):
The financial sector uses the savings to Invest (I) which is an Injection to the economy. Firms will invest via expanding their business production and grow.
Injection is flows of money which can increase aggregate income and economic activity. This is a form of return to the firms. Investment is current expenditure that can obtain benefits in the future.
4. Government Sector:
Government’s 2 major roles in the economy: impose tax and expenditure.
When individuals pay Taxes (T) (can be individual taxes, corporate taxes, capital gains tax, stamp duty etc.), this is a Leakage of the government sector.
The government sector uses the tax revenue to spend on the economy as Government expenditure (G).This spending is an Injection of money into the economy.
Government expenditure (G) can be social welfare payments, unemployment benefits, defence, infrastructure projects, schools, hospitals. This can stimulate the economy.
5. Foreign Sector: international trade with other countries, i.e. Exports (X) and Imports (M)
Exports (X) are the selling of goods and services to a foreign country. It is an Injection of money into the economy.
Imports (M) are the buying of goods and services from a foreign country. It is a Leakage of money into the economy.
In a perfect world, the total leakages equal to injections (very unlikely). This is Equilibrium.
S + T + M = I + G + X
Leakages = Injections
If there is more leakages, the economy is expected to contract.
If there is more injections, the economy is expected to expand.
For an economy to grow, it is ideal to have more injections than leakages.
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