The operation of an economy is the next section to focus on and involves understanding the production of goods and services, the distribution and exchange of these goods and services etc PART 2 will discuss the provision of income, provision of employment and quality of life through the business cycle, and the circular flow of income.


The Four Factors of Production

Economic resources are the goods and services available to individuals and businesses used to produce valuable consumer products. The classic economic resources are land, labour, capital and entrepreneurship. These economic resources are also referred to as the factors of production.



Land refers to the resources provided by nature such as the soil, plants, timber and other natural resources found within a nation’s economy.



Labour represents workers or human capital who utilise their skills (physical and mental effort) to transform raw and national resources into consumer goods. Human capital can also be improved through training or educating workers to complete technical functions or business tasks.



Capital has two meanings, the first being any monetary resources companies use to purchase natural resources, land and other capital goods. Capital also refers to the major physical asses producers and companies use to produce goods or services. These assets include buildings, production facilities, equipment, vehicles etc.



Entrepreneurship is also considered a factor of production because without these people, raw materials will remain as raw materials unless someone takes action and initiates a business or production company to change these raw material into consumer goods. They are also responsible for the allocation and distribution of these resources or consumer products to individuals and other businesses in the economy.


Distribution of Goods and Services

Distribution is a step in the economic process which brings goods and services from those who produce them to those who consume them. There are many stages between the making of a product and its delivery to the customer. For example, stages include getting strawberries farmed and collected by farmers, distributed to wholesalers who then distribute to retailers and such then to the consumers who pay the ultimate price for the strawberries.


Exchange of Goods and Services

The exchange of goods and services is a win-win situation in which a consumer will pay a certain amount of money for strawberries supplied by the seller who values the money more than the strawberries.


Business Cycle

The Business Cycle refers to the fluctuations that depict economic activity experienced within an economy over time. A business cycle is described in terms of periods of booms and busts, otherwise known to be the extremities from expansions and contractions within an economy.


During expansions, the economy is growing and ‘expanding’. Household incomes are rising, consumer spending and demand increases which results in thriving businesses who may decide to hire more people to supply more goods and services to meet the demand in the market. This results in lower unemployment rates and better quality of life for everyone in the economy!


However , during periods of a contraction, consumer spending is controlled and reduced which have a major impact on businesses to stay operational without people demanding their goods, more jobs are cut, wages are reduced and the vicious cycle continues until the economy hits its lowest economic state known as a recession. Unemployment rates increase and everyone’s quality of life worsen.

Business Cycle

The Trend line you can see in the graph above illustrates the long term growth trend that the economy follows in order to stay sustainable. Government intervention may be needed to bring the economic fluctuations as close to the trend line as possible to minimise the economic impacts that will result in either too much growth (too much growth will affect the value of the australian dollar, more on that later!) or no growth at all.


Other important keywords:

  • A recession is not just when the economy is unwell. It is recognised when a country experiences 6 months (two consecutive quarters) show a decrease in GDP.
  • A depression has no technical meaning behind it but it is referred to as a severe recession.


The Circular Flow Of Income

The Circular Flow of Income is a model which reflects how the economy works and a whole through the flow of goods, services, and money.

Circular Flow of Income

According to the model provided above, it can be cleared stated that the steps include:

  1. Individuals offer businesses with their labour in return for income (y)
  2. Businesses then also produce output (O) which are purchased by individuals using their income (Y)
  3. In the financial sector, banks offer the financial services within the economy. Banks receive savings (S) from individuals who possess excess income and use this money to fund businesses who seek loans to grow their business. This is referred to as investment (I).
  4. In the government sector, leakages are in the form of taxation (T) which is derived from everyone in the economy who has an income about a certain threshold. This is a form of income to the government to fund government spending (G) for the whole economy such as things regarding to infrastructure and better roads, hospitals, healthcare etc.
  5. Money flows out of the economy and into the overseas sector for imports (M) and injections are made through exporting (X) our goods into the overseas sector in the form of monetary gain.
  6. Steps 3, 4, and 5 all have their forms of leakages and injections that ultimately benefit firms and businesses in the growing economy.


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