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The economy is a complex system, but at its core, it’s all about people and the choices they make. These decision-makers are known as economic actors. They participate in economic activity by consuming goods and services, producing goods and services, and setting policies that influence the overall economic landscape. There are three main types of economic actors: households, businesses, and governments.
Understanding economic actors
What’s it: Economic actors refer to the participants in economic activities in an economy. They make decisions based on their own goals and motivations. Traditionally, economists assume that these actors make rational choices, aiming to maximize their own well-being. However, this doesn’t mean they have perfect information or unlimited resources.
- Households: Individuals and families who consume goods and services strive to get the most satisfaction (utility) from their spending. They also earn income by contributing factors of production like labor, land, or capital to the economy.
- Businesses: Organizations that produce goods and services aim to make a profit. They purchase factors of production from households and transform them into goods and services that are then sold back to households (and other businesses) in the market.
- Governments: Public institutions responsible for regulating economic activity and setting policies. Their primary goals often include achieving sustainable economic growth, maintaining stable prices, promoting full employment, and ensuring a balanced balance of payments (international trade). They use a variety of tools like taxes, spending, and regulations to achieve these objectives.
External Sector: This sector encompasses economic actors (households, businesses, governments) located outside a specific country’s borders. They interact with domestic actors through international trade (exporting and importing goods and services) and capital flows (investments). The health of the external sector can significantly impact a country’s overall economic performance.
The core macroeconomic sectors
Economists group economic actors into the following three categories:
In an open economy, economic activity also involves the external sector. It represents economic actors abroad, which interact with domestic economic actors through international trade and capital flows. However, if we break down its components again, the external sector also consists of the three economic actors mentioned above.
Furthermore, transactions between these sectors involve exchanging goods and services and money as a means of payment. Economists describe the flow of goods and income in a circular flow diagram.
Several authors added the voluntary sector to the three sectors. Unlike the business sector, this sector is neither profit-oriented nor dependent on the government sector. Sometimes, we refer to it as the third sector, the community sector, or the non-profit sector. Examples of the voluntary sector are charities, communities, cooperatives, foundations, advocacy groups, and social welfare organizations.
Furthermore, if you dissect economic actors in more detail, you will likely find a wide variety of actors, including:
- Household: lower class, middle class, and upper class
- Company: commercial enterprises, unincorporated businesses, social enterprises
- Public service organizations: educational, health care, utility institutions
- Political bodies: parliaments, central and local governments, international organizations, and government agencies.
- Financial institutions: central banks, financial services authorities, commercial banks, pension funds, stock exchanges, and insurance companies
- Legal institutions: courts and law firms.
- Educational and cultural institutions: universities, R&D organizations, and arts institutions.
- Local community: a community of professions, hobbies, and interests.
- Civil society organizations: non-governmental organizations, ranging from the environment and human rights to culture
- Professional associations: trade unions, business associations, and chambers of commerce.
Household
The household sector consists of individuals. They are the owners of various factors of production available in the economy. They may be workers, landowners, or entrepreneurs.
In the factor market, the household sector offers firms a factor of production. In return, they receive a variety of incomes, including:
- Wages for labor
- Rent for used land
- Profit for entrepreneurship
- Interest for capital
Another source of income is transfer payments from the government, such as pension benefits and unemployment benefits.
Households use that income for consumption or for saving. Before allocating to the two, they must pay taxes. The income remaining after paying taxes is called disposable income.
Households use disposable income to buy several products from the business sector’s product market. Products fall into three main categories: durable goods, non-perishable goods, and services.
Households also save some of their disposable income to accumulate wealth. They place it into real assets such as property or financial assets such as time deposits, stocks, mutual funds, and bonds.
Households as rational economic actors
Economists assume the household sector is rational in making economic decisions. They will try to maximize satisfaction (utility) from the consumption of goods and services.
Utilities are subjective. The same item may satisfy you and your friends in different ways. Likewise, your satisfaction may also be different when you are at different times and locations.
Business
The business sector consists of various organizations that produce goods and provide services. Their motive is for profit. They sell goods or provide services to other sectors and earn revenue as compensation.
The business then uses the money to purchase various inputs in the factor market. It recruits workers, buys raw materials, and buys capital goods.
In general, we can group business activities into three sectors based on their stages in the value chain:
- Primary sector. This sector consists of various businesses, with the main activity being the extraction and processing of natural resources. Examples of their activities are mining, forestry, fisheries, plantations, and agriculture.
- Secondary sector. This sector consists of various businesses that produce industrial goods (such as shoes, clothes, cars, and books), build houses and buildings, and provide water, electricity, and gas. They process raw materials from the primary sector into semi-finished and finished goods.
- Tertiary industry. This sector covers a wide range of businesses providing services. They serve various activities such as transportation, finance, retail, and health.
Meanwhile, based on the legal form, we can categorize the businesses into the following three groups:
- Sole proprietorship. The owner has the right to all profits and bears unlimited liability on the company’s debt.
- Partnership. Businesses have two or more owners. They share profits and responsibilities as agreed, and each has unlimited liability for the company’s debt.
- Corporation. We also often refer to it as a company, where the legal entity is separate from the owner. Owners control the company through the shares they own. They receive a share of the profits (dividends) in proportion to their share ownership. Furthermore, they are not responsible for the company’s debt. Some of these companies sell their shares to the public through stock exchanges (known as public companies). Others do not (referred to as private companies).
Government
The government consists of institutions that are tasked with regulating and issuing policies to influence economic activity. They include the central government, ministries, central banks, and local governments.
The macroeconomic objectives of the government sector are:
- Achieve sustainable economic growth
- Stable inflation
- Full employment
- Balance of payments equilibrium
The government sector issues policies in addition to regulations. Two well-known examples of macroeconomic policy are fiscal and monetary policy. Both affect aggregate demand, which in turn impacts production activities and aggregate supply.
The government collects taxes from the business and household sectors to finance operations and macroeconomic policies. If tax revenues are less than expenditures, the government runs a budget deficit. It must borrow to cover the deficit, for example, by issuing debt securities.
Furthermore, the government also launched structural policies to influence the supply side of the economy. Examples of policies are privatization, infrastructure development, improving the education system, and promoting competition.
The government also carries out various economic activities in several sectors, especially where they are less attractive to private sectors (businesses). Examples are infrastructure development, defense, health and education services, and rail transportation. The private sector considers these activities high-risk or unprofitable.
Beyond the core: the voluntary sector
The economic landscape extends beyond the traditional trio of households, businesses, and governments. The voluntary sector, composed of non-profit organizations (NPOs) like charities, foundations, and social welfare groups, plays a vital role in supplementing and sometimes even pioneering economic activity. Unlike for-profit businesses, NPOs prioritize social good over generating revenue. They deliver essential services, advocate for important causes, and contribute significantly to areas like education, healthcare, and environmental protection.
NPOs often operate in sectors where government intervention might be limited or where market forces fail to meet societal needs. They can provide innovative solutions, fill gaps in social services, and empower communities. For instance, an NPO might run a free after-school program, offer job training to the underprivileged, or advocate for sustainable environmental practices.
The voluntary sector also fosters a sense of civic engagement and social responsibility. By involving volunteers and donors, NPOs create a space for individuals to contribute to their communities and make a positive impact. Additionally, NPOs can act as watchdogs, holding businesses and governments accountable for their actions. They can also play a crucial role in disaster relief and humanitarian aid efforts, offering vital support during times of crisis.
In conclusion, the voluntary sector is an integral but sometimes overlooked player in the economic sphere. Its contributions to social well-being, service delivery, and community empowerment are undeniable.
The global stage: international actors in play
The economic world transcends national borders. Today’s interconnectedness, driven by international trade and capital flows, creates a dynamic environment where economic actors from various countries interact. This international dimension, encompassed by the external sector, significantly influences domestic economies.
International trade allows countries to specialize in producing goods and services for which they have a comparative advantage. This exchange fosters efficiency, promotes economic growth for participating nations, and offers consumers a wider variety of goods at potentially lower prices. Countries export (sell) goods and services that they produce in abundance while importing (buying) those that they produce less efficiently or not at all.
Capital flows, another crucial aspect of the global stage, involve the movement of money across borders. Foreign investments can provide businesses with much-needed funding for expansion or innovation, ultimately contributing to economic development. For instance, a foreign company might invest in a local start-up, bringing in capital and expertise.
However, international trade and capital flows are not without their complexities. Increased competition from foreign companies can force domestic firms to adapt and innovate to remain competitive. Fluctuations in currency exchange rates can impact the price of imported goods and the competitiveness of exports. Additionally, trade imbalances can occur when a country imports significantly more than it exports, potentially leading to economic instability.
Understanding the dynamics of the external sector is crucial for navigating the complexities of the globalized economy. By acknowledging the role of international actors and the interplay between trade, investment, and currency fluctuations, we gain a deeper understanding of how a country’s economy interacts with the wider world stage.
