Factors of Production and Circular Flow of Income - Coursework Example

? and Section # of Economics Economics in broad terms refers to how people make their choices between scarce resources and allocate these resources in competitive uses. It is a social science that describes how people will seek to act.There are a number of models that economist uses that differentiates economics from other social sciences. Economics model assumes that people are rational meaning they have well-ordered preferences, and want to maximize either satisfaction or profit in order to fully utilize their utility, and they want to do best from the resources that are given to them. Another concept for example used is of ceteris Paribus which is a Latin term for all other things remaining constant. This assumption is made in order to facilitate deductions from theories, holding all except one variable constant. For example the demand curve is drawn holding all factors affecting demand, except price, constant. (Wessels, 2006) Economics is built upon three concepts of scarcity, choice and opportunity cost. Scarcity refers to unlimited wants and limited resources that involve making a choice as resources need to be allocated in alternative uses. All economic agents face the basic economic problem and the choices they make involves a tradeoff. (Wessels, 2006) Economics can be divided into two parts that is Microeconomics and Macroeconomics. Microeconomics deals with individual units such as households, firms, markets etc. for example individual demand for bicycle in the economy, or market demand for cars. On the other side Macroeconomics deals with aggregates and the economy as a whole, i.e. what determines the price of all goods. For example aggregate demand for all goods and services in the economy. (Wessels, 2006) Analyses in economics are based on positive and normative statements. Positive statements refer that can be checked against evidence for example an increase in interest rates encourage savings. While normative statements refer to what should be , for example firms should be encouraged to invest. (Wessels, 2006) Factors of Production Land refers to natural resources that are created by nature and not those earning assets created by man. Labour refers to the physical and mental ability of a human provided to a firm. It includes the part of human population that is willing to provide to economics production. Capital that is also called as ‘reproducible capital’ that is the sum of earning asset created by man, while the last Entrepreneur is the risk taker and organizes other three factors of production. (Mokyr, 1985) There are certain characteristics of different factors of production but two common characteristics in all includes that all factors of production are limited in amount and they have alternative uses as well. At any point in time one can increase the amount of land, capital and labour it has but it important to note is that it is finite and cannot increase beyond its fixed a capacity. More over these factors of production can be used to produce many different goods and services and hence are substitutable and interchangeable at many levels. This helps one to decide what, how and for whom to produce. (Goldberg, 2000) Characteristics of labour are important in determining wages and volume of production. Firstly labour is a human factor and the active factor. It has its own will to do anything, likes dislikes and so needs to work along with other factors in production. Also labour is different in efficiency, skills, also is mobile and perishable. Each labour has different efficiency and can be moved between jobs. Quality of labour can be improved by improving its productivity by training, educating workforce and by providing them better medical facilities. (Marshall, 2007) Land is the primary and passive factor of production as it is the basis from which production starts and it cannot do anything itself as it has be operated by labour. It could be used in multiple ways such as for agriculture; setting up factory but it cannot be moved from one place to another as it is permanent and is in fixed quantity. Fertility of land also differs from place to place. Its productivity can be improved depending if it’s a level land as compared to hilly or a desert and also, situation of land if located near to market rather than remote area. Capital on the other side is a manmade factor and increase as a person saves more and invests. It is a secondary factor of production and can be transferred from one place to another such as machines. It is a passive factor as needs labour to work on it to produce anything and it is counted for wear and tear that is depreciation. Its productivity can be increased as there is more and more capital available this could be done by encouraging people to save more, reducing taxes to encourage investment, development of banks offering higher return on savings. (Marshall, 2007) Entrepreneurship is the ability to organize other three factors of production. One needs to be passionate about what to achieve and adapt to changing circumstances. Also they need to be energetic by putting up extra efforts than others make strong decisions quickly. One can be motivated to work hard and succeed in coming up with creative ideas and innovative products. (Marshall, 2007) Circular Flow of Income 1Figure 2 Importance of Circular Flow of Income and Markets The concept of circular income gives us a clear cut of the economy as it specifies the process of flow of income in the economy. It can easily relate to whether economy is performing efficiently or not and if there is any disturbance in the smooth functioning of the flow of income. Circular flow of income is very important as it identifies relative importance of the sectors in the economy as it identifies the percentage of output of different sectors such as primary, secondary, and tertiary. This could help in the calculation of National Income through the flow of funds accounts. This flow of funds provides a complete picture of all monetary transactions in the economy and the link between all other sectors in the economy is explained in terms of borrowing and lending as well.(Kennedy, 2011) This could help to understand the equilibrium position of the economy which occurs where the injections are equal to leakages. These inflows and outflows help understand them and keep a balance between them for example imports are leakages in the economy and if they increase government can take appropriate actions to reduce them for example by increasing taxes and duties on them. This could in turn help to shape trade policy for the country as well where it could take steps to discourage imports and encourage exports.(Kennedy, 2011) Creation of markets is also explained as Product, factor and capital markets are developed as it is evident from Figure 2. Households buy goods and services in product market and sell resources in factor market. While firms raise capital from Capital markets and sells products in product market by employing resources from factor market. This explains the relationship between producers and consumers.(Kennedy, 2011) This flow of income also identifies the inflationary and deflationary gaps as for example savings and taxes are depressants of the circular flow of income as it reduces income and discourage investment. This leads to fall in employment, income and output of the economy that leads to depressionary pressures in the economy. On the other side consumption encourages income, output and hence increases inflationary tendency.(Kennedy, 2011) Circular flow of income helps in the controlling the economy too as it identifies where the policies are required to be implemented either fiscal or monetary policy. Monetary policy involves changes in money supply and interest rates so this could help to stabilize the economy when to control consumption, by increasing interest rates. On the other side for the fiscal policy to work it controls government expenditure and the level of taxes in an economy. It represents that the economy is in equilibrium where Leakages Savings(S) + Taxes (T) + Imports (M) = Injections Investments (I) + Government Expenditure (G) +Exports (X). So when I +G+E < S+T+I means that the government needs to adjust its revenue and expenditure by encouraging more investment i.e. by reducing taxes and increase in government expenditure on development projects. So it highlights the importance of fiscal policy as Taxes are leakages in the economy while government spending is injection. (Kennedy, 2011) BIBLIOGRAPHY Wessels, Walter J.Barron’s Economics 4th Edition.Barron’s Education series (2006) Goldberg, Kolman. An Introduction to the market system. Printed in the United States of America. M.E Sharpe Inc. (2000) Mokyr, Joel .The Economics of Industrial Revolution.Printed in the United States of America. Rowman and Littlefield Publishers Inc. (1985) Top of Form Bottom of Form Marshall, Alfred. Principles of Economics.Printed in Delhi by V.K Publications (2007) John Kennedy, M Maria. Macroeconomic Theory. Printed in Delhi. PHI Learning Private Limited (2011) Read More