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The Operation of an Economy

An Overview of the Operation of an Economy

In this post, we will talk about the operation of an economy, as part of the Prelim Economics Course. In economics, we look at two broad types of economic systems:

  • The market, or free enterprise economy; and
  • The planned economy.

In both of these systems, we see that the operation of these economies lies to three fundamental questions raised by the economic problem:

  1. What to produce?
  2. How much to produce?
  3. How to produce?
  4. To whom to distribute?

Within these questions, we see a variety of economic issues arise. These include the distribution and exchange of goods and services, the provision of income and employment and the circular flow of income.

Have a look at these videos below to enhance your understanding of these issues, and the overall operation of an economy.


The Production of Goods and Services

In an economy, firms produce goods and services. There are four factors of production:

  1. Land
  2. Labour
  3. Capital
  4. Enterprise


The Distribution and Exchange of Goods and Services

Firms are always posed with the question: who do they distribute their goods and services to? This helps with decision-making processes, referring back to the fur production questions.


The Circular Flow of Income (5-Sector Model)

The circular flow of income model is a visual way of representing how funds and resources flow throughout all sectors in the economy. In the 5-sector model, we have:

  1. The Household Sector;
  2. The Firms Sector;
  3. The Financial Sector;
  4. The Government Sector; and
  5. The Overseas Sector.

According to this model, an economy is in equilibrium when leakages are equal to injections, or, S+T+M = I+G+X.