What is an economy?

1. WHAT IS AN ECONOMY?
• How to describe something as complex as
an economy
• As a Metaphor ? Eg,
a bowl of spaghetti ?
(Why?)
each strand represents
an economic transaction

2. As a machine ?

3. As a biological system

4. As a model
• Economists thankfully have developed a
simple model ( to represent the major
areas of activity and flows of money
between them) known as “The Circular
Flow of Income”
• FEATURES:
• 5 major areas (or “Sectors” of activity)
• Income/money flows between these
sectors

5. CIRCULAR FLOW OF INCOME
2 Sector Model
1. Household Sector comprises total
population
- who are consumers
- and producers (owners of resources)
- Households receive income for providing
resources ( land, labour, capital,enterprise)
to the business sector
2. Business Sector – where all production
occurs and sells goods and services

6. 2 Sector Model
Income (Y)
Household Business
Consumption

7. 3 Sector Model
3. Finance Sector – where people SAVE
and BORROW money, eg, banks, building
societies, credit unions, superannuation
companies, sharemarket, etc.
(Business borrowing is known as
INVESTMENT)

8. 3 Sector Model
Household Business
Finance
Savings Investment

9. 4 Sector Model
4. Government Sector – (Federal, state and
local) where the Government TAXES
people (and businesses) and SPENDS
money (eg subsidies to businesses,
welfare payments to households)

10. 4 Sector Model
Household Business
Finance
Savings Investment
Govt.
Tax Govt Spending

11. 5 Sector Model
5. Overseas Sector – There are many flows
of money in and out of Australia. The most
well known flows are payments overseas
(IMPORTS) and payments to Australians
(EXPORTS) for goods.

12. 5 Sector Model
Household Business
Finance
Savings Investment
Govt.
Tax Govt Spending
Overseas
Imports
Exports

13. Equilibrium: Leakages and
Injections
Leakages (Red Lines) are money that leaves
the circular flow eg.
– Savings
– Tax
– Imports
Injections (Green Lines) are money that enters
the economy eg.
– Investment
– Govt. spending
– Exports

14. 5 Sector Model
Household Business
Finance
Savings Investment
Leakages Injections
Govt.
Tax Govt Spending
Overseas
Imports
Exports

15. Equilibrium: Leakages and
Injections
If leakages are higher than injections Total
Income (Y) will fall
If injections are higher than leakages Total
Income (Y) will rise
If leakages = injections Total Income (Y) will
not change ie
The Economy is in “EQUILIBRIUM”