The relationship between firms and households

1.0 Introduction

Factors of production are land, labor capital and entrepreneurship. Households are the owners of factors of production and the firms are users of factors of production. Firms use households (factors of production) to pay factor incomes which is rent, wages, interest and profit. Firms will use factor of production to produce output in the way of goods and services, which will be purchased by the household. In this way household incur their expenditures.

1.1 Body

Circular flow diagram is the visual model of economy which shows how money flows through the markets among household and firms. Circular flow model consists of four separate models which each sequentially adding sectors or markets and also thus providing the greater complexity and realism. The four flows are flow factors of production from households to firms, flow of incomes from firms to household, flow of output of goods and services from firms to households and lastly flow of expenditures from households to firms.

1.1.1 Circular Flow Diagram http://wpcontent.answcdn.com/wikipedia/commons/thumb/b/b8/Circular_flow_of_goods_income.png/350px-Circular_flow_of_goods_income.png

Above circular flow diagram divides the economy into two sectors which is one concerned with the producing goods and services, and the other with consuming them. All the four flows which has been stated as been illustrated in the circular flow above. In the diagram the outer flows of incomes and expenditures are flows of money and the inner flows of factors of productions and outputs are the flows of goods and services.

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1.1.2 Households

Households have the main function because they are the workers and also consumers. So they provide labour to firms and compensated with wages from the firms. Other then that as consumers they also buy goods and services from firms which constitutes as consumer expenditure.

1.1.3 Firms

Firms are the producers of goods and services. Labour and capital is the input of the production process. Labour comes from households where wages are paid and the capital investment can be funded either by retained profits or borrowing from the financial sector.

1.1.4 Relationship between Households and Firms

In a daily life example we are consumers who are working for a firm to earn wages. Because we working for the company the company makes profit and increase their production in their goods and services. When we are the households we receive wages from firms and we use it to buy goods and services produce by firms.

2.0 Withdrawals and Injections

Withdrawals take place when there are movements of funds out of the circular flow in income. The three important things in withdrawals are Savings (S), Taxation (T) and Imports (M). In Savings households wont be spent all the factors income received on the current or even immediate consumption. Households also prefer to keep some for future or deferred consumption. For example households make their saving in the form of deposits at financial institutions such as banks.

Taxation is where households have to pay to the government as taxes from their income. For example when household receive their wages their will be a deduction column as their income tax. Imports is where households willing to buy goods and services from abroad rather than consuming domestically produced goods and services.

An injection takes place when there are movements of funds into the circular flow of incomes. The three important things in injection are Investments (I), Government expenditure (G) and Exports (X). In Investments households saved income which was deferred consumption there are later invested back in the circular flow/economy. In government expenditures government use all the taxes received from households and then it’s creates in flow of funds back into the circular flow. For example government expenditure includes road building, construction and more. Government use the total taxes which had collected from household to build road, hospital, buildings and other. In exports firms may sell some of their goods and services to foreign countries. In the economy expenditure from the foreign countries by foreigners becomes an injection.

2.1 Withdrawals and Injections diagramUntitled.jpg

3.0 Total Withdrawals equal wit Total Injectionsmmmm.jpg

In the terms of the expanded circular flow of the income model the state of equilibrium takes parts when the total withdrawals that occur in the economy. It can be proven as:

Savings + Imports +Taxes = Investment + Government Spending + Exports

OR

S + M+T = I + G + X

4.0 Conclusion

Disequilibrium is the stage where the economic activity is not equal, and it is where withdrawals become greater than injections or even withdrawals less than injections, where also known as the stage of equilibrium when Withdrawals equal with injections.

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5.0 Bibliography

1. Mankiw, Gregory N. Principles of Economics. 4th edition, ©2007 Thomson Southwestern,

<http://bizcovering.com/business-and-society/circular-flow-of-income-model-of-an-economy>

2. Sloman, John (1999), Economics, 3rd edition, Pretice Economics.

3. Graeme Chambelin, Lind Yueh (2006), Macroeconomics, Thomson Learning.

QUESTION 2

1.0 Introduction

The fluctuations in the level of the economics activities of a country over time are often be the best illustrated by the Business Trade Cycles. Business trade cycle is also known as the periodic fluctuation in the rate of the economic activity as it been measured by levels of employment, prices and also production.

1.1 Body

The four main concepts in business trade cycles are full employment, unemployment, recession and inflation. Full employment takes place at the level of economic activity when all available at factors of production are fully utilized. In the business trade cycles, there is upward swings and also downward swings. The periods of adversity are alternate with the periods of business prosperity. Every boom is followed by a vice versa and also a slump. This business trade cycle is simply means that the whole course of trade or even business activity which is passes through all the phases of prosperity and also adversity.

2.0 Phrases in Business Trade Cyclemk.jpg

2.1 Phases in Business Trade Cycle

Economists actually divided the business cycles into two main phases which is depression and recovery then boom and slump. Boom and slump mark turning points in the cycles.

2.1.1 Depression

In this phase, the whole economy will be in depression mode and the business is at the lowest stage. Other than that the general purchasing power of the community is very low. In the productive activity, both production of consumer goods and the production of capital goods are at the low level. There are some of the main characteristics in depression. Depression makes the amount of production and trade shrinks. It is also increases unemployment and the overall prices become decreases. All the profits and wages decreases and the income of the community fall at a very low level. Other than that aggregate expenditure together with the effective demand also goes down. For example if a firm receiving a new investment or replacement investment they will make it delay as long as they are possible to go for it. Other than that in stock markets the prices of all shares and securities will be fallen to a very low level. Even in practically all the construction activity no matter in buildings or machinery comes to an end.

2.1.2 Recovery

Recovery is also known as expansion. In this phase the depression period comes to an end. In recovery phase all the economic situations become favourable. As money become cheap it makes the other materials and also factors of production easy and cheap. Here the aggregate demand becomes low aggregate supply. Other than that the productive activity also has been increased and the entrepreneurs also have sufficient financial backing. This makes the further investment and production increased. For example when a construction company ends all their projects in depression phase, now the same company will start receiving orders and employing more employees to create more income and employment. Lastly the whole economy will be moving faster towards the boom phase.

2.1.3 Boom

Boom is also known as peak phase and it is a turning point in trade cycle. This phase is the highest point in economic recovery. In this phase there is a large number of production and also trade. There is also a high level of employment and also the job opportunities in limited amount to permit a good deal of labour mobility. Aggregate Demand will be equal with Aggregate supply. Overall it makes the prices rise. Other then that it also makes a rising structure in interest rates so then a bullish tendency rules makes stock exchanges. For example when a construction company starts to make more profit and inverse more the will improve their business and may need more employees. So then it makes the company offer more employment and it also makes the company get high level of investment.

2.1.4 Recession

Recession is the sharp slow down in the economic activity, but slight different from depression which is more severe and also pronged downturn. Aggregate demand is low then aggregate supply. As the depression created the conditions of recovery, it is similarly and the boom conditions generate their own checks. All the idle factors have been employed and also further demand must raise their prices, but the quality is also inferior. In this phase there should be less efficient workers which have been taken for higher wages. The interest rates will rises and also other materials. Finally the costs have started to upward swing.

3.0 Conclusion

Macroeconomics is mainly associate to the balance between Aggregate Demand and Aggregate supply in the whole economy/country. If the aggregate Demand becomes higher than Aggregate Supply the excess demand will be cause inflation. If the aggregate Demand becomes lower than aggregate supply, then the insufficient demand will cause recession and unemployment.

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