Introduction to Economics

Chapter One
Basics of Economics

1.1 Definition of economics

 Economics is one of the most exciting disciplines in
social sciences.
 There is no universally accepted definition of economics
 This is because different economists defined economics from
different perspectives like:
a. Wealth definition,
b. Welfare definition,
c. Scarcity definition, and
d. Growth definition
 Cont..
 Hence, its definition varies as the nature and scope of
the subject grow over time. But, the formal and
commonly accepted definition is as follow:
 Economics is the branches of social science that
studies about the production, distribution and
consumption of goods and services
 Economics is a social science which studies about
efficient allocation of scarce resources so as to attain the
maximum fulfillment of unlimited human needs.
 It is social science that studies how society chooses how
to allocate scarce resources for present to future
generation.
 Cont…

 The following statements are derived

from the above definition:
I. Economics studies about scarce resources;
II. It studies about allocation of resources;
III. Allocation should be efficient;
IV. Human needs are unlimited
V. The aim (objective) of economics is to
study how to satisfy the unlimited human
needs up to the maximum possible degree by
allocating the resources efficiently.
 1.2 The Rationales of Economics
 There are two fundamental facts that provide the foundation
for the field of economics.
Why does Economics is emerged as a science?
1. Human (society‘s) material wants are unlimited.
2. Economic resources are limited (scarce).
 The basic economic problem is about scarcity and choice
since there are only limited amount of resources available to
produce the unlimited amount of goods and services we
desire.
 Thus, economics is the study of how human beings make
choices to use scarce resources as they seek to satisfy their
unlimited wants.
 1.3 Scope and method of analysis in economics
1.3.1 Scope of economics
• The field and scope of economics is expanding
rapidly and has come to include a vast range of
topics and issues. In the recent past, many new
branches of the subject have developed, including
development economics, industrial economics,
transport economics, welfare economics,
environmental economics, and so on. However,
the core of modern economics is formed by its
two major branches.
 Scope of economics

Microeconomics and Macroeconomics.

That means economics can be analyzed at
Micro and Macro level.
A. Microeconomics is concerned with the
economic behavior of individual decision making
units such as households, firms, markets and
industries. In other words, it deals with how
households and firms make decisions and how
they interact in specific markets.
B.Macroeconomics is a branch of economics
that deals with the effects and consequences of
the aggregate behavior of all decision
making units in a certain economy. In other
words, it is an aggregative economics that
examines the interrelations among various
aggregates, their determination and the causes
of fluctuations in them. It looks at the
economy as a whole and discusses about the
economy-wide phenomena.
 The two major branches of Economics
Microeconomics Macroeconomics
• Studies individual economic • Studies an economy as a
units of an economy. whole and its aggregates.
• Deals with individual • Deals with national income
income, individual prices, and output and general price
individual outputs, etc. level
• Its central problem is price • Its central problem is
determination and allocation determination of level of
of resources. income and employment.
• Its main tools are the • Its main tools are aggregate
demand and supply of demand and aggregate
particular commodities and supply of an economy as a
factors. whole.
 The two major
Microeconomics
branches of Economics
• Macroeconomics
•

• Helps to solve the central problem

• It helps to solve the central problem of what,
of full employment of resources in
how and for whom to produce‘ in an economy
the economy.
so as to maximize profits.• Concerned with the determination
of equilibrium levels of income and
• Discusses how the equilibrium of a consumer,
employment at aggregate level.
a producer or an industry is attained.
Examples:
• Examples: Individual income, individual
• National income, national savings,
general price level, national output,
savings, individual prices, an individual firm‘s
aggregate consumption, etc.
output, individual consumption, etc.
 Cont…

• Note that: Both microeconomics and macroeconomics are

complementary to each other. That is, macroeconomics
cannot be studied in isolation from microeconomics.
• 1.3.2 Positive and normative analysis/Economics

• Is economics a positive science or normative science, or

both? What is your justification?
• Economics can be analyzed from two perspectives:

• Positive economics and Normative economics.

 Positive and normative analysis/Economics
A. Positive economics: it is concerned with analysis of
facts and attempts to describe the world as it is.
It tries to answer the questions what was; what is; or what
will be?
It does not judge a system as good or bad, better or worse.
Example:
 The current inflation rate in Ethiopia is 12 percent.
 Poverty and unemployment are the biggest problems in
Ethiopia.
 The life expectancy at birth in Ethiopia is rising.
 Minimum-wage laws cause unemployment
 Positive and normative analysis/Economics
B. Normative economics: It deals with the
questions like, what ought to be? Or what the
economy should be? It evaluates the desirability
of alternative outcomes based on one‘s value
judgments about what is good or what is bad.
In this situation since normative economics is
loaded with judgments, what is good for one may
not be the case for the other. Normative analysis
is a matter of opinion (subjective in nature) which
cannot be proved or rejected with reference to
facts.
Example:
 The poor should pay no taxes.
There is a need for intervention of government in the
economy.
 Females ought to be given job opportunities.
Any disagreement on a normative statement can be solved
by voting.
Any disagreement on positive statements can be checked
by looking in to facts.
 1.3.3 Inductive and deductive reasoning in
economics
• The fundamental objective of economics, like
any science is the establishment of valid
generalizations about certain aspects of human
behavior. Those generalizations are known as
theories. A theory is a simplified picture of
reality. Economic theory provides the basis for
economic analysis which uses logical reasoning.
There are two methods of logical reasoning:
Inductive and Deductive.
A. Inductive reasoning is a logical method of
reaching at a correct general statement or theory
based on several independent and specific correct
statements. In short, it is the process of deriving a
principle or theory by moving from facts to
theories and from particular to general economic
analysis.
Inductive method involves the following steps.
1. Selecting problem for analysis
2. Collection, classification, and analysis of data
3. Establishing cause and effect relationship
between economic phenomena.
b) Deductive reasoning is a logical way of arriving at a
particular or specific correct statement starting from a
correct general statement. In short, it deals with
conclusions about economic phenomenon from certain
fundamental assumptions or truths or axioms through
a process of logical arguments. The theory may agree or
disagree with the real world and we should check the
validity of the theory to facts by moving from general to
particular.
Major steps in the deductive approach include:
1. Problem identification
2. Specification of the assumptions
3. Formulating hypotheses
4. Testing the validity of the hypotheses
1.4 Scarcity, choice, opportunity cost and production
possibilities frontier

a. Scarcity
• The fundamental economic problem that any human
society faces is the problem of scarcity.
• Scarcity refers to the fact that all economic resources
that a society needs to produce goods and services are
finite or limited in supply. But their being limited
should be expressed in relation to human wants. Thus,
the term scarcity reflects the imbalance between our
wants and the means to satisfy those wants.
Resources is any things natural or manmade that can be used in
production of goods and services

Resources

Scarce/
Free Resources Economic
Eg. Sunshine Resources
The following are examples of scarce resources.
 All types of human resources: manual,
intellectual, Skilled and specialized labor;
 Most natural resources like land (especially,
fertile land), minerals, clean water, forests
and wild animals:
 All types of capital resources ( like machines,
intermediate goods, infrastructure ); and
 All types of entrepreneurial resources.
Goods - tangible product from which
Services - intangible product a consumer
derive satisfaction
 Economic Resources
Economic resources are usually classified into four
categories.
1. Labor: refers to the physical as well as mental efforts of human
beings in the production and distribution of goods and services.
The reward for labor is called wage/Salary
2. Land: refers to the natural resources or all the free gifts of nature
usable in the production of goods and services.
The reward for the services of land is known as rent.
3. Capital: refers to all the manufactured inputs that can be used to
produce other goods and services. Example: equipment,
machinery, transport and communication facilities, etc.
The reward for the services of capital is called interest.
4. Entrepreneurship: refers to a special type of
human talent that helps to organize and manage
other factors of production to produce goods and
services and takes risk of making loses.
The reward for entrepreneurship is called profit.
Entrepreneurs are individuals who:
 Organize factors of production to produce
goods and services.
 Make basic business policy decisions.
 Introduce new inventions and technologies
into business practice.
 Look for new business opportunities.
 Take risks of making losses.
Note: Scarcity does not mean shortage. We
have already said that a good is said to be
scarce if the amount available is less than the
amount people wish to have at zero price. But
we say that there is shortage of goods and
services when people are unable to get the
amount they want at the prevailing or on
going price. Shortage is a specific and short
term problem but scarcity is a universal and
everlasting problem.
Scarcity is a universal problem that faces all
societies because there are not enough
resources to produce everything people
want.
A shortage is a situation in which the
quantity demanded is greater than the
quantity supplied. Shortages occur when
producers are not or can not offer goods or
services at the current price.
 b. Choice
• If resources are scarce, then output will be limited. If output is
limited, then we cannot satisfy all of our wants. Thus, choice
must be made. Due to the problem of scarcity, individuals, firms
and government are forced to choose as to what output to
produce, in what quantity, and what output not to produce.
• In short, scarcity implies choice. Choice, in turn, implies cost.
That means whenever choice is made, an alternative opportunity
is sacrificed. This cost is known as opportunity cost.
• Scarcity → limited resource → limited output → we
might not satisfy all our wants →choice involves costs
→ opportunity cost
 c. Opportunity cost

• In a world of scarcity, a decision to have more of one thing, at

the same time, means a decision to have less of another thing.
The value of the next best alternative that must be sacrificed
is, therefore, the opportunity cost of the decision.
• Definition: Opportunity cost is the amount or value of the
next best alternative that must be sacrificed (forgone) in
order to obtain one more unit of a product.
• The 1st best alternative opportunity is chosen, obtained,
gained
• The next best alternative opportunity is forgone (Scarified)
lost, missed
• Opportunity cost: the 2nd alternative, but not 3rd , 4th , 5th
Opportunity cost of goods = the amount of the next best
alternative give up/ the amount of good gained ( the 1st best
alternative)
 OC = given up/gained = Cost/gained
OCxy = given up Y/gained X
When we say opportunity cost, we mean that:
 It is measured in goods & services but not in
money costs
 It should be in line with the principle of
substitution.
In conclusion, when opportunity cost of an activity
increases people substitute other activities in its
place.
 4. The Production Possibilities Frontier or Curve (PPF/ PPC)

• The production possibilities frontier (PPF) is a curve that

shows the various possible combinations of goods and
services that the society can produce given its resources and
technology.
• To draw the PPF we need the following assumptions.
a. The quantity as well as quality of economic resource
available for use during the year is fixed in supply. (Fixed
Resources)
b. There are two broad classes of output to be produced over
the year. (Only two products are produced)
c. The economy is operating at full employment and is
achieving full production (efficiency).
d. Technology does not change during the year.
(fixed technology)
e. Some inputs are better adapted to the
production of one good than to the production
of the other (specialization).
Suppose a hypothetical economy produces food
and computer given its limited resources and
available technology (table 1.1).
 Table 1.1: Alternative production possibilities of a
certain nation
Types of Unit Production alternatives
Product A B C D E

Food Metric 500 420 320 180 0

tones
Computer numbers 0 500 1000 1500 2000

We can also display the above information with a graph.

 Production Possibilities Frontier or Curve

• Production Possibilities Frontier or Curve

Y Food
500 A
B F
420

320 C
G

D
180

E X Computer
500 1000 1500 2000
Production Possibilities Frontier

All points on the PPF are attainable and efficient

Point A,B,C,D and E are attainable and efficient

Point G is attainable but inefficient

Point F is unattainable
 The Production Possibilities Frontier or Curve

The PPF describes three important concepts:

i) The concepts of scarcity: - the society cannot have unlimited
amount of outputs even if it employs all of its resources and
utilizes them in the best possible way.
ii) The concept of choice: - any movement along the curve indicates
the change in choice.
iii) The concept of opportunity cost: - when the economy produces
on the PPF, production of more of one good requires sacrificing
some of another product which is reflected by the downward
sloping PPF. Related to the opportunity cost we have a law known
as the law of increasing opportunity cost. This law states that as we
produce more and more of a product, the opportunity cost per unit
of the additional output increases. This makes the shape of the PPF
concave to the origin.
The opportunity cost of a good =

The amount of the next

best alternatives scarified

The amount of good

gained
Example: Referring to table 1.1 above, if the economy is
initially operating at point B, what is the opportunity
cost of producing one more unit of computer?
Solution: Moving from production alternative B to C we
have:

OC = 320 – 420 = | - 100 | = 0.2

1000 – 500 500
(The economy gives up 0.2 metric tons of food per
computer)

34
 Home Take Exam 5%
Q1. Assume that a certain simplified economy produces
only two goods. Bread and guns with a given resources and
technology. The following tables give the various possible
combinations of the production of the two goods.

Types of Production Alternatives

products
A B C D E F

Guns 0 10 20 30 40 50

Bread 3000 2800 2400 1800 1000 0

 Home Take Exam 5%
a. Calculate the opportunity cost of from A to B
b. Calculate the opportunity cost of from D to E
c. Calculate the opportunity cost of from C to B
d. Calculate the opportunity cost of from E to D
e. Calculate the opportunity cost of from C to D
• Note: interpret the your result for each
5. Economic Growth and the PPF
Economic growth or an increase in the total output level
occurs when one or both of the following conditions occur.
1. Increase in the quantity or/and quality of economic
resources.
2. Advances in technology.
Economic growth is represented by outward shift of the PPF.
Food

Old PPF New PPF

computer
Figure 1.2: Economic growths with a new PPC
An economy can grow because of an increase in
productivity in one sector of the economy. For example,
an improvement in technology applied to either food or
computer would be illustrated by a shift of the PPF along
the Y- axis or X-axis. This is called asymmetric growth
(figure 1.3).
1.5 Basic economic questions
Economic problems faced by an economic system due to
scarcity of resources are known as basic economic
problems. These problems are common to all economic
systems. They are also known as central problems of an
economy. Therefore, any human society should answer
the following three basic questions.
 Basic Economic Questions
a. What to Produce? (Types of product)
• This problem is also known as the problem of allocation of
resources. It implies that every economy must decide which
goods and in what quantities are to be produced. The
economy must make choices such as consumption goods
versus capital goods, civil goods versus military goods, and
necessity goods versus luxury goods. As economic
resources are limited
• we must reduce the production of one type of good if we
want more of another type. Generally, the final choice of
any economy is a combination of the various types of
goods but the exact nature of the combination depends
upon the specific circumstances and objectives of the
economy.
 Basic Economic Questions
b. How to Produce?(Techniques of production)
• This problem is also known as the problem of
choice of technique. Once an economy has reached
a decision regarding the types of goods to be
produced, and has determined their respective
quantities, the economy must decide how to
produce them - choosing between alternative
methods or techniques of production. For example,
cotton cloth can be produced with hand looms,
power looms, or automatic looms. Similarly, wheat
can be grown with primitive tools and manual
labour, or with modern machinery and little labor.
Broadly speaking, the various techniques of production
can be classified into two groups:
labour-intensive techniques and capital-intensive
techniques.
A labour-intensive technique involves the use of more
labour relative to capital, per unit of output.
A capital-intensive technique involves the use of more
capital relative to labour, per unit of output. The choice
between different techniques depends on the available
supplies of different factors of production and their
relative prices. Making good choices is essential for
making the best possible use of limited resources to
produce maximum amounts of goods and services.
c. For Whom to Produce? (social status, types of consumers)
This problem is also known as the problem of
distribution of national product. It relates to how a
material product is to be distributed among the
members of a society. The economy must decide,
for example, whether to produce for the benefit of
the few rich people or for the large number of poor
people. An economy that wants to benefit the
maximum number of persons would first try to
produce the necessities of the whole population
and then to proceed to the production of luxury
goods.
 1.6 Economic Systems

The way a society tries to answer the above

fundamental questions is summarized by a
concept known as economic system.
An Economic system is a set of organizational
and institutional arrangements established to
answer the basic economic questions.
Customarily, we can identify three types of
economic system. These are Capitalism,
Command and Mixed economy.
 1.6.1 Capitalist economy
Capitalism is the oldest formal economic system
in the world. It became widespread in the middle
of the 19th century. In this economic system, all
means of production are privately owned, and
production takes place at the initiative of
individual private entrepreneurs who work mainly
for private profit. Government intervention in the
economy is minimal. This system is also called
free market economy or market system or laissez
faire.
 Features of Capitalistic Economy
A. The right to private property: The right to private
property is a fundamental feature of a capitalist economy.
As part of that principle, economic or productive factors
such as land, factories, machinery, mines etc. are under
private ownership.
B. Freedom of choice by consumers: Consumers can
buy the goods and services that suit their tastes and
preferences. Producers produce goods in accordance with
the wishes of the consumers. This is known as the
principle of consumer sovereignty.
C. Profit motive: Entrepreneurs, in their productive
activity, are guided by the motive of profit-making
D. Competition: In a capitalist economy, competition
exists among sellers or producers of similar goods to
attract customers. Among buyers, there is competition to
obtain goods. Among workers, the competition is to get
jobs. Among employers, it is to get workers and
investment funds.
E. Price mechanism: All basic economic problems are
solved through the price mechanism.
F. Minor role of government: The government does not
interfere in day-to-day economic activities and confines
itself to defense and maintenance of law and order.
G. Inequalities of income: There is a wide
economic gap between the rich and the poor.
H. Existence of negative externalities: a
negative externality is the harm, cost, or
inconvenience suffered by a third party
because of actions by others. In capitalistic
economy, decision of firms may result in
negative externalities against another firm or
society in general.
 Advantages of Capitalistic Economy

 Flexibility or adaptability: It successfully adapts itself to

changing environments.
 Decentralization of economic power: Market
mechanisms work as a decentralizing force against the
concentration of economic power.
 Increase in per-capita income and standard of living:
Rapid growth in levels of production and income leads to
higher per-capita income and standards of living.
 New types of consumer goods: Varieties of new
consumer goods are developed and produced at large scale.
 Growth of entrepreneurship: Profit motive creates and
supports new entrepreneurial skills and approaches.
Optimum utilization of productive resources: Full
utilization of productive resources is possible due to
innovations and technological progress.
 High rate of capital formation: The right to private
property helps in capital formation.
Disadvantages of Capitalistic Economy
 Inequality of income: Capitalism promotes economic
inequalities and creates social imbalance.
 Unbalanced economic activity: As there is no check
on the economic system, the economy can develop in an
unbalanced way in terms of different geographic regions
and different sections of society.
 Exploitation of labour: In a capitalistic economy,
exploitation of labour (for example by paying low
wages) is common.
Negative externalities: are problems in capitalistic
economy where profit maximization is the main
objective of firms. If economic makes sense for a
firm to force others to pay the impacts of negative
externalities such as pollution.
1.6.2 Command economy
Command economy is also known as socialistic
economy. Under this economic system, the
economic institutions that are engaged in
production and distribution are owned and
controlled by the state. In the recent past, socialism
has lost its popularity and most of the socialist
countries are trying free market economies.
 Main Features of Command Economy
 Collective ownership: All means of production are owned by
the society as a whole, and there is no right to private property.
 Central economic planning: Planning for resource allocation is
performed by the controlling authority according to given socio-
economic goals.
 Strong government role: Government has complete control over
all economic activities.
 Maximum social welfare: Command economy aims at
maximizing social welfare and does not allow the exploitation of
labour.
 Relative equality of incomes: Private property does not exist in
a command economy, the profit motive is absent, and there are no
opportunities for accumulation of wealth.
All these factors lead to greater equality in income distribution, in
comparison with capitalism.
 Advantages of Command Economy
 Absence of wasteful competition: There is no place
for wasteful use of productive resources through
unhealthy competition.
 Balanced economic growth: Allocation of resources
through centralized planning leads to balanced economic
development. Different regions and different sectors of the
economy can develop equally.
 Elimination of private monopolies and inequalities:
Command economies avoid the major evils of capitalism
such as inequality of income and wealth, private
monopolies, and concentration of economic, political and
social power.
 Disadvantages of Command Economy
 Absence of automatic price determination: Since all
economic activities are controlled by the government, there
is no automatic price mechanism.
 Absence of incentives for hard work and efficiency:
The entire system depends on bureaucrats who are
considered inefficient in running businesses. There is no
financial incentive for hard work and efficiency. The
economy grows at a relatively slow rate.
 Lack of economic freedom: Economic freedom for
consumers, producers, investors, and employers is totally
absent, and all economic powers are concentrated in the
hands of the government.
 Red-tapism: it is widely prevalent in a command
economy because all decisions are made by government
officials.
 1.6.3 Mixed Economy

• A mixed economy is an attempt to combine the

advantages of both the capitalistic economy and the
command economy. It incorporates some of the features
of both and allows private and public sectors to co-exist.
Main Features of Mixed Economy
 Co-existence of public and private sectors: Public and
private sectors co-exist in this system. Their respective
roles and aims are well-defined. Industries of national
and strategic importance, such as heavy and basic
industry, defense production, power generation, etc. are
set up in the public sector, where as consumer-goods
industry and small-scale industry are developed through
the private sector.
 Economic welfare: Economic welfare is the most
important criterion of the success of a mixed economy. The
public sector tries to remove regional imbalances, provides
large employment opportunities and seeks economic welfare
through its price policy. Government control over the private sector
leads to economic welfare of society at large.
 Economic planning: The government uses instruments
of economic planning to achieve co-ordinated rapid
economic development, making use of both the private and
the public sector.
 Price mechanism: The price mechanism operates for
goods produced in the private sector, but not for essential
commodities and goods produced in the public sector.
Those prices are defined and regulated by the government.
Economic equality: Private property is allowed, but rules exist
to prevent concentration of wealth. Limits are fixed for owning
land and property. Progressive taxation, concessions and
subsides are implemented to achieve economic equality.
Advantages of Mixed Economy
 Private property, profit motive and price mechanism: All
the advantages of a capitalistic economy, such as the right to
private property, motivation through the profit motive, and
control of economic activity through the price mechanism, are
available in a mixed economy. At the same time, government
control ensures that they do not lead to exploitation.
 Adequate freedom: Mixed economies allow adequate
freedom to different economic units such as consumers,
employees, producers, and investors.
Rapid and planned economic development: Planned economic
growth takes place, resources are properly and efficiently utilized,
and fast economic development takes place because the private and
public sector complement each other.
 Social welfare and fewer economic inequalities: The
government‘s restricted control over economic activities helps in
achieving social welfare and economic equality.
Disadvantages of Mixed Economy
 Ineffectiveness and inefficiency: A mixed economy might not
actually have the usual
advantages of either the public sector or the private sector. The
public sector might be inefficient due to lack of incentive and
responsibility, and the private sector might be made ineffective by
government regulation and control.
 Economic fluctuations: If the private sector is not
properly controlled by the government, economic
fluctuations and unemployment can occur.
 Corruption and black markets: if government
policies, rules and directives are not effectively
implemented, the economy can be vulnerable to
increased corruption and black market activities
1.7 Decision making units and the circular flow model
There are three decision making units in a closed
economy. These are households, firms and the
government.
i) Household: A household can be one person or more
who live under one roof and make joint financial
decisions. Households make two decisions.
a) Selling of their resources, and
b) Buying of goods and services.
ii) Firm: A firm is a production unit that uses economic
resources to produce goods and services.
Firms also make two decisions:
a) Buying of economic resources
b) Selling of their products.
iii) Government: A government is an organization that
has legal and political power to control or influence
households, firms and markets. Government also provides
some types of goods and services known as public goods
and services for the society.
The three economic agents interact in two markets:
1. Product market: it is a market where goods and
services are transacted/ exchanged.
That is, a market where households and governments buy
goods and services from business firms.
2. Factor market (input market): it is a market where
economic units transact/exchange factors of production
(inputs). In this market, owners of resources (households)
sell their resources to business firms and governments.
The circular-flow diagram is a visual model of the
economy that shows how money (Birr), economic
resources and goods and services flows through markets
among the decision making units.
For simplicity, let‘s first see a two sector model where we
have only households and business firms. In this case,
therefore, we see the flow of goods and services from
producers to households and a flow of resources from
households to business firms. In the following diagram, the
clock – wise direction shows the flow of economic
resources and final goods and services. Business firms sell
goods and services to households in product markets
(upper part of the diagram). On the other hand, the lower
part shows, where households sell factors of production to
business firms through factor market.
The anti clock wise direction indicates the flow of
birr (in the form of revenue, income and spending
on consumption). Firms, by selling goods and
services to households, receive money in the form
of revenue which is consumption expenditure for
households in the product market. On the other
hand, households by supplying their resources to
firms receive income. This represents expenditure
by firms to purchase factors of production which is
used as an input to produce goods and services.
 A Two sector model
FIRMS
HOUSEHOLD
•Produce and sell
 Buy and consume
goods and services
goods and services
•Hire and use
• Own and sell
factors
factors
of production
of production
 A Three sector model
HOUSEHOLDS
FIRMS Buy and consume
•Produce and sell goods and services
goods and services •Own and sell
•Hire and use factors
factors of production
GOVERNMENT
of production • Provide social
services
• Provide supports
• Collect taxes
• Buy goods and
services
• Hire and uses
factors of production
 A Three sector model
• The service provided by the government goes to
the households and business firms. The
government might also support the economy by
providing income support to the households and
subsidies to the business firms. At this point you
might ask the source of government finance to
make the expenditures, payments and additional
supports to the firms and households. The main
source of revenue to the government is the tax
collected from households and firms.
Any question?