National Income Accounting

The economic cycle

The total economy, which is the subject matter of macro-economics, are joined together by innumerable individual transactions. These transactions are the subject matter of micro-economics. The participants may also be grouped to some degree into separate groups - these are the decision makers represented by individual households and individual firms. To complete the picture one would also have participant from the financial sector, government departments and the firms in the foreign sector.

Households in the economy use goods and services to satisfy the almost unlimited human needs and to do this they put at the disposal of firms the productive resources they own - in the form of labour, land, capital and entrepreneurship; for which they are remunerated by the firms through wages, rent, interest and profit. This then forms the economic cycle.

The value of the products (goods) and services have a price that is determined by the market and also signifies on a continuous basis the relative value to the participants so that they can (as consumers) decide how to allocate their scarce and limited income and to firms (as producers) how to allocate their productive resources an produce what consumers want most.

This interaction between participants normally takes place through the market in which buyers and sellers come together to trade. It is through the market that prices and quantities are determined. The price acts as signals to other economic processes such as production, commerce, consumption, imports and exports, financing activities, interest rates costs and profit opportunities. This is an extremely intricate web of dynamic and fragile relationships that can be horribly skewed and negatively affected by extraneous events such as natural disasters, wars and government intervention. Poverty and misery is usually the result of the resultant mis-allocation and waste of scarce resources.

To summarise - there is a flow of goods and services to consumers (households) and a reverse flow of money to firms and a flow of productive resources from households to firms and a reverse flow of money from firms to households as they pay for the resources used in the production of goods and services. These four flows are the same in quantum from a National Income Accounting point of view.