Core Economic Concepts: Income Flow, Production, Distribution
Circular Flow of Income
The circular flow of income describes the set of relationships between economic agents, primarily involving:
- The payment of income from companies to families in exchange for work and other productive factors.
- The payment of prices from families to businesses in exchange for goods and services produced by them.
In economies that rely on the market to allocate resources, relationships exist between families, businesses, and the state within two main markets:
- The Market for Goods and Services: In this market, companies provide families with the goods and services they demand in exchange for payment.
- The Market for Factors of Production: Here, families provide the factors of production (like labor, land, capital) that businesses demand, in exchange for income (wages, rent, interest, profit).
Businesses offer goods and services to the market, setting the price for these goods and services, and this generates income for the companies. In turn, companies pay taxes to the state, and the state may provide subsidies to businesses. Families purchase goods and services from the market, representing expenses for the families. Families also pay taxes to the state, and the state provides transfers like pensions and social benefits.
In the factor market, businesses demand factors of production. In return for these factors, businesses pay income to families. Families offer factors of production to the market and receive income (rent, wages, interest, profit) from this market.
Production Perspectives
What is a Company?
A company is a union of natural resources, labor, and capital organized to produce and distribute goods and services that society demands, aiming to earn a profit in return.
Different Perspectives on Production
There are three different perspectives on production:
- Economic Perspective: Production is viewed as a process to meet the needs of families, using factors of production managed by companies. This aligns with the purpose of production within the circular flow of income.
- Functional-Utilitarian Perspective: This practical perspective focuses on what production achieves: adding value to things, making them more useful or desirable than before processing.
Value Added: The increase in worth resulting from the production process, giving an item greater value than it had before being processed.
- Technical Perspective: This describes how production takes place. It involves combining production resources using specific technology to obtain a product.
Technology: A set of procedures, equipment, and machines that combine material factors, human resources, and organizational arrangements to produce a good or service.
How to Produce? The Technical Perspective
The technology chosen should be the most efficient one. Efficiency means using the minimum number of factors of production necessary to obtain the desired level of output. Technical efficiency involves the optimal use of productive resources, often by selecting the most cost-effective technologies available.
Distribution
Distribution is essential for making goods and services available for consumption. Many companies specialize in distributing products manufactured by others. Distribution ensures goods and services are in the right place at the right time to be acquired by buyers. By making products accessible, distribution creates utility of place, form, and time.
Distribution occurs through distribution channels.
Distribution Channels
A distribution channel is any means used to ensure that products follow the path from producer to consumer. There are two main types:
- Direct Channel (Owned): The producing company owns the channel. The producer sells directly to the customer without intermediaries.
- Indirect Channel (External Distributors): This channel involves third parties and does not belong to the producing company. It uses intermediaries to distribute the products. The length of the channel depends on the number of intermediaries involved. Key intermediaries include:
Intermediaries
- Wholesalers: Intermediaries that typically buy products in large quantities from producers or other wholesalers and sell them to other intermediaries (like retailers), not usually directly to the final consumer. This is known as wholesale trade.
- Retailers: Intermediaries who sell products directly to the final consumer, usually in smaller quantities. This is known as retail trade.
Other Distribution Systems
- Franchise: A business arrangement where a franchisor grants a franchisee the right to use its brand, products, and business model. The franchisee operates the local business according to the franchisor’s standards and often pays royalties.
- Teleshopping: Sales conducted through television advertisements, with orders typically placed by phone and payment via credit card or cash on delivery.
- E-commerce (Online Sales): Sales conducted over the Internet, with various online payment methods.
- Vending Machines/Automated Retail: Unattended machines dispense products upon payment.