Economy and its process

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Income earning, spending and saving activities are called economics activities. Income is source of spending, earning and savings. Income is generated through production process. Production, consumption and investment are three basic economic activities.

Meaning of Economy

Economy is a system by which people earn their living. It comprises production units like farms, factories, shops and banks etc. all these production units together make economy. Economy provides goods and services to consumers and producers.

Economy Provides

Economy provides goods and services. Goods or services provided to consumers satisfy their wants. Goods or services which directly satisfy human wants are called consumer goods or services. Use of goods determines whether it is producer goods or consumer goods.

Goods and services are broadly classified as:

  1. Consumer goods and services

  2. Producer goods and services

Consumer Goods and Services

Goods or services which directly satisfy human wants are called consumer goods or services.

  1. Consumer Goods:

    • Goods which directly satisfy human wants are called consumer goods.

    • It can be classified into two categories:

      i. Single use consumer goods. Examples: food items like milk, sugar etc., other goods like soap, oil, paper etc.

      ii. Durable use consumer goods. Examples: furniture, shoes, refrigerator, radio etc.

  2. Consumer Services:

  • Goods which directly satisfy human wants are called consumer goods.

  • All services are single use. As services produced and consumed can’t be used again.

Producer Goods and Services

Goods or services which are used for producing more goods and services are called producer goods or services.

  1. Producer Goods:

    • Goods which are used for producing more goods and services are called producer goods. Examples: raw material, machines, vehicles etc.

    • Goods are not only used to produce more goods but also to produce more services. X-ray machine and stethoscope is best example of it.

  2. Producer Services:

  • Services which are used for producing more goods and services are called producer Services.

  • Example: services like banking, transport, advertising etc.

  • As services produced and consumed can’t be used again. They can be used ones.

Vital Process of Economy

There are three vital processes of an economy: Production, Consumption and investment. They are inter-related.

Production

  • Activities that create goods or services are called productions.

  • It includes not only making of various goods but also the services.

  • Production includes the goods made and services provided in economy.

Consumption

  • It can be described as act of satisfying one’s wants.

  • It includes consumption of goods and services both.

  • Example: We consume food, clothes, furniture etc., Services of tailors, barbers, tutors etc.

  • It is determined by level of production in economy.

Investment

  • Addition of new capital goods to existing stock of capital goods is called investment.

  • Stock produced during a year is not generally acquired for consumption in that year.

  • Generally production exceeds consumption during year. It is due to following reason:

  1. Goods lying with production unit

  2. Durable goods acquired by production unit

Stock Investment vs. Fixed Investment

  1. Stock Investment

    • Additional capital goods to existing stock of capital goods are inventory or stock investment.

    • Stock at beginning of year is called as opening stock. Similarly stock exist at end of year is called closing stock.

    • Excess of closing stock over opening stock is called inventory investment.

  2. Fixed Investment

  • Acquiring producer goods by production unit is called fixed investment.

  • Investment equals sum of inventory invention and fixed investment.

  • Capital formation is alternative name of investment.

Gross Investment vs. Net Investment

  • Sum of inventory investment and fixed investment is called gross investment.

  • Gross investment is distinguished from net investment.

Savings

Income spent on acquiring goods and services for satisfaction is called consumption expenditure. Unspent part of income is called ‘saving’. Savings play very important role in production process.

Inter Relationship Between Economic Processes

  • Production is the source of consumption and investment.

  • Consumption provides motivation for production and Investment.

  • Investment determines the level of production.

  • Saving is the major source of financing investment.