Reading: The Flow of Inputs and Outputs

The Flow of Inputs and Outputs

Many of the factors of production (or resources) are provided to businesses by households. For example, households provide businesses with labor (as workers), land and buildings (as landlords), and capital (as investors). In turn, businesses pay households for these resources by providing them with income, such as wages, rent, and interest. The resources obtained from households are then used by businesses to produce goods and services, which are sold to the same households that provide businesses with revenue. The revenue obtained by businesses is then used to buy additional resources, and the cycle continues. This circular flow is described below in Figure 1, which illustrates the dual roles of households and businesses:

  • Households not only provide factors of production (or resources) but also consume goods and services.
  • Businesses not only buy resources but also produce and sell both goods and services.
Inputs and Outputs diagram for Businesses and Households. Businesses produce and sell products to households and buy inputs from households. Businesses pay incomes for inputs. The outputs of businesses are goods and services (products). Households buy products from firms and provide inputs to firms. Households pay revenues for outputs. The Inputs of Households are labor, capital, land, and entrepreneurship.

Figure 1. The Circular Flow of Inputs and Outputs

The Questions Economists Ask

Economists study the interactions between households and businesses and look at the ways in which the factors of production are combined to produce the goods and services that people need. Basically, economists try to answer the following three sets of questions:

  1. What goods and services should be produced to meet consumersneeds? In what quantity? When should they be produced?
  2. How should goods and services be produced? Who should produce them, and what resources, including technology, should be combined to produce them?
  3. Who should receive the goods and services produced? How should they be allocated among consumers?

The answers to these questions depend on a country’s economic system—the means by which a society (households, businesses, and government) makes decisions about allocating resources to produce products and about distributing those products. The degree to which individuals and business owners, as opposed to the government, enjoy freedom in making these decisions varies according to the type of economic system. We will explore the various types of economic systems and how each system answers these questions in a module on economics and economic systems.


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