Introduction to Economics

The Five Sector Model

At the beginning of this section, we defined Economics as the study of the way in which consumers, businesses, the government and the external sector interact to generate production and employment. These groups constitute four of the five "sectors" that we will use in this model. The fifth sector is the financial sector; the banks.

A cursory glance at the diagram below may seem intimidating, but you will quickly understand that this is just an enhanced version of the circular flow diagram that we examined on the previous page.

In this diagram, the five "sectors" of the economy are shown in green boxes. We will start at the box with the word “consumers” in it. Consumers own resources. In particular, we have access to the labour resource that businesses need. We can choose to "sell" our labour to a business. That is, we can go and get a job, and the business will pay us for our labour. This is represented in the black box.

When businesses have access to labour, they will pay for it. The payment which is made when we provide labour to a business is called our wage. When we receive a wage, we are likely to spend the majority of it on the goods and services made by businesses. All of these interactions are represented at the top of the diagram.

However, we do not spend all of the money that we receive. Some of it "leaks" from this simple system. The “leakages” are represented in the blue boxes on the left hand side of the diagram. Some of our wage will be taken by the government. This is referred to as “income tax”. Another percentage of our income will be put into the bank as saving. And finally, some of our money will be spent on goods and services that are made in other countries.

These leakages are balanced by the fact that there are also injections into our economy. The government uses the money that it collects in income tax to provide us with goods and services such as schools, hospitals, street lights and a defence force. The financial sector takes the money that we save and makes it available for borrowing. Generally people will use borrowed money to purchase capital assets, and so this is a very healthy option for the economy. And finally, just as we buy products made overseas, some people from overseas will purchase Australian goods and services. We refer to these purchases as "exports". These various activities are called "injections", and they are represented in the orange boxes on the right hand side of the diagram.

As you grow to understand this diagram, you will see that it can be used to make some preliminary predictions about the impact of certain events on the economy. For example, if income tax rates were to increase, and the government did not increase their spending in the economy, you can see that businesses would not need to provide as many goods or services. If this happened, then they wouldn’t need to employ as many people. All of these interactions can be concluded from following the lines on the diagram above.

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