I found the diagram above in Wikipedia, and I think I'll spend a few posts making considerations on it. First i should try and explain what it means. I have no real knowledge on Economics, but it doesn't seem so difficult. This picture depicts the way our national economies work today. It is like a machine with its different parts, and the economists, which are the engineers of these types of machine love to oil it and make it run better and faster and bigger. So how does it work?
There are 3 national players and an international one, and 3 markets where transactions occur.
The first player consists of the households, the families (or as we are also known, the consumers), of which some work, some are retired, some are too young, and some are sick, and some are hard working, and some are lazy, some are smart and some are less. It's us. Out of those that can and will work we offer labour to the workforce market. In return we receive wages. With these wages we consume goods and services from the commodities market, or we make savings and investments in the financial market expecting to receive interests in return or we make loans for our private consumption (buying a house or a car).
The second player consists of the corporations, and they demand labour from the workforce market and resources (like energy) or raw materials in order to produce goods and services, which are sold to other corporations, households and government in the commodities market in return for profit. They obtain capital from the financial market in the form of loans or investment (shares) which they use to set up their logistics and improve their production capability. Banks which are corporations controlling the financial markets will often make investments in commodities for speculation (such as food, causing the prices to rise and some people to starve).
The third player is our government, these are some of our own kind which we elect to represent us, they collect taxes from wages and profits and transfer benefits or redistribute wealth and provide welfare (education, social subsidies, health, roads, justice, police, defense, etc.). They also provide laws to regulate private and corporate behavior. They make savings and investments in the financial market and often also require loans. They used to have also the power to manage money issuing to control inflation, but since the euro this capability is limited to the political power of each nation in the European institutions, so their influence in the economy is basically in tax policy, interest rates and regulation.
The forth player is represented in the picture as Foreign, and are all the other countries out there, with which we do business, that is we import and export goods and services, and we receive or supply capital via direct investment or aid through the financial markets.
Modern economic theories requires that regulations and protectionism in the functioning of these described markets be kept to a minimum, competition to a maximum, and information shared, such that they work fine. When this happens, then in some magical way, production will match consumption (when there is demand new companies will appear, when there is exceeding some companies will go bankrupt), prices will be kept to an acceptable value that consumers can afford and employment... well, no one can guarantee anything about that, but if the economy grows then there should be nothing to worry about.
To have an idea of how well the labour market is doing we look at unemployment rates. To have an idea of how well the commodity market is doing we look at GDP (Gross Domestic Product attempts at estimating how much a country is producing by calculating how much it consumes - from the magical formula Consumption = Production - GDP = Consumption + Investment + Government Spending + Exports - Imports) for size and inflation (the commodities price variation) for dynamics. To know how well the financial market is doing, well you can look at interest rates or the bank profit declarations, it's normally doing well except when you hear of sub-prime crisis (which means banks have lent money at high interest rates to people who can't pay back)!
So everything should be alright and everybody happy when unemployment and inflation are low and GDP and interest rates are high (if the central bank lowers interest rates it normally means it thinks corporations are in trouble and need to borrow money, and lowering will stimulate the economy). And how do you do that? What is the fuel that powers the engine? Well most people would claim it's to consume, consume, consume... corporations profits stay high and they employ more people, government collects more taxes, wages increase, there's more money around for people to spend, spending makes people happy, government collects more taxes and may decide to lower them, stimulating even further the economy, more corporations appear, prices lower, people consume more, and so on in a virtuous cycle, or so we wished... (but that's another post)
Did it always look like this, our economy? This will be the topic of the next post.
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