What’s it: The household sector includes individuals or groups of individuals. A household may consist of one or several people who live in the same household and share food. They may include one family or another group of people.
On the one hand, households become consumers of goods and services produced by the business sector. Their consumption is a major determinant in stimulating economic growth in several countries. Their spending accounts for most of the gross domestic product (GDP).
On the other hand, they provide inputs to the business sector in exchange for wages, interest, and profits. They provide factors such as entrepreneurship and labor. For example, they become entrepreneurs and unite the other three factors of production (land, labor, and capital). As owners, they have a claim to the business and earn profits as compensation.
How does the household sector contribute to the economy?
The household sector acts as a supplier and a consumer, depending on which market they play. Let us discuss their contribution to factors, products, and financial markets.
Supplying inputs to business
Households supply inputs to the business sector in factor markets. They provide labor as an input in the production process. They may work as blue-collar workers and do manual work like in a factory. Or, they work as white-collar workers to do professional, managerial, or administrative work. They receive salaries, wages, and other benefits such as insurance and pensions.
In addition, households also supply entrepreneurship. They act as entrepreneurs. They take risks by uniting other inputs (capital, labor, and land) to produce goods and services. In return, they make a profit.
Consumers for goods and services
Households act as consumers in the product market. They buy goods and services from the business sector using their supply inputs’ money. And the money they spend flows into the business sector as income.
As consumers, households play a strategic role in driving the economy. Their money contributes significantly to aggregate demand (measured by GDP), usually exceeding spending by the business, government, and external sectors.
Thus, when households spend more money on goods and services, the economy can grow at a higher rate. In addition, their spending encourages businesses to increase production and recruit more workers. Eventually, it leads to an increase in output and a decrease in the unemployment rate in the economy.
Source for financial capital
Households supply financial capital to the business sector. They set aside their income as savings. For example, they invest in financial instruments such as bonds issued by the business and government sectors. In return, they receive income such as coupons and capital gains.
Meanwhile, companies use funds from bond issuance to buy capital assets or open new factories. Meanwhile, the government may use it to build infrastructure.
Households can also save their money in the bank. In return, they earn interest. Savings in the bank also contribute to financial capital. For example, banks channel household savings to real sectors such as manufacturing.
Meanwhile, some households may invest in real assets such as property, which provides them with rental income. Say, they rent a shophouse to tenants to open a retail business.
Financial and real assets above represent household wealth, an important factor influencing consumption and income. For example, when their assets appreciate, they become richer and are willing to spend more money on goods and services. Finally, it stimulates the economy to grow. We call how the increase in the value of their assets impacts economic growth the “wealth effect.”
Households also act as taxpayers to the government. The taxes they pay become revenue for the government, which uses it for capital expenditures, routine expenditures, and transfer payments such as unemployment benefits.
Households earn income from supplying inputs to the business sector. In addition, they also get income from government transfer payments. And they do not spend all their income on goods and services. Rather, they have to pay taxes first – the total income minus the tax is known as disposable income.
Disposable income is available for consumption and savings. As I explained above, for example, households save their income in financial markets by buying financial assets such as bonds. Meanwhile, the remaining dollars they spend on goods and services.
Back to taxes. Households pay taxes directly to the government. Examples are individual income tax and capital gains tax. Or, they pay indirectly, such as value added tax, levying on the goods and services they consume.
How does the household sector relate to other sectors?
Economists use the circular flow model to describe how the household sector relates to other sectors, such as business and government. They present it in a diagram, which shows us how output, income, and inputs flow between the sectors, as I described above.
Let’s take a three-sector economic model: households, business, and government. The interactions between households and businesses occur in factor, financial, and product markets. In product markets, households buy goods and services provided by businesses. Businesses earn money as income and then use it to buy inputs provided by households in factor markets.
In factor markets, households supply inputs to businesses to produce goods and services. In this market, businesses act as buyers while households act as suppliers.
Then, households also earn income from providing labor inputs and transfer payments. Likewise, businesses can also earn income by selling goods and services to the government. And both sectors pay taxes to the government.
Lastly, households, businesses, and governments interact in the financial market apart from interacting in the factor and product markets. For example, households buy debt securities issued by businesses and governments. As a return, they earn income such as coupons and capital gains.
What to read next
- Circular Flow of Income: Types and Descriptions
- Economic Actors: Types and Roles
- Macroeconomic Sector: Types, Roles
- Government Sector: Meaning, Budget, and Impact on the Economy
- Household Sector: Definition and Role in the Economy
- Business Sector: Meaning, Types of Companies
- External Sector: Its Effect on the Economy
- 4 Types of Business Sector You Need to Know
- How Does the Government Play A Role In the Economy?