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 INPUT 2.
The Organization of an Economic System
In producing goods and services to satisfy consumer demands and to make

profits, firms must use the productive resources: land, labor, capital and the enterprise. In
the process, decisions about what and how much to produce are made by millions of
households and firms. These decisions generate a circular flow of income which provides
a concept on how an economic system works.
I. The Circular Flow Model

2) business receipts 1) costs of living
Money
Goods and Services
Business firms Households
Labor and Capital
Money (rents, wages, salaries, dividends, interest, etc.)

3) costs of production 4) consumers income
The widely used "circular flow model" (Fig. 1) furnishes a highly simplified
model of an economic system. This cyclical operation of demand, output, income and
new demand is called the circular flow of income in the economy. It is the mechanism
by which we decide how to use and what to pay the resources.
In this model, economic units are classified into two groups: 1) households, and
2) business firms. These interact in two sets of market: 1) markets for consumer goods
and services, and 2) resource market.
Households are the consumers of the economy's output of goods and services;
business firms are the ones engaged in buying and hiring or resources and the production
and sales of goods and services.
The upper half of the figure represents the markets for consumer goods and
services. Households as consumers and business firms as sellers interact within the
market. Goods and services flow from business firms to consumers and a reverse flow of
money from consumers to business firms also take place. Prices of goods and services
from the connecting link between the two flows.
The lower half of the represents the markets for resources. The services of labor
and capital in their many forms flow from resource owners (households) to business
firms. The reverse flow of money in payment for these resources occurs in such forms as
wages salaries, rents, dividends, interest, etc.
Money circulates continuously from household to business firms and back to the
household again. The sale of goods and services places money at the disposal of business
firms for the purchase of resource service to continue production. The sale or hire of the
services of resources places money at the disposal of resource owner for the purchase of
goods and services. The money flow takes on four familiar aspects as it makes a complete
circuit. It is consumer's cost of living at point (1) as it leaves consumers' hands. It is
business receipts for business firms at point (2). At point (3), the money flow becomes
costs of production, while at point (4), it is consumers' income.
II. The function of an Economic System
Every economic system must somehow perform five related functions:
1. determine of what to produce
This is a problem of determining what wants in the aggregate is most

important and in what degree they are to be satisfied. Since the resources of
the economy are scarce, all wants cannot be fully satisfied. The problem is
one of picking and choosing from the unlimited scope of wants those most
important to the society as a whole.
2. organization of production
An economic system must determine how resources are to be organized to

produce the desired goods in the proper quantities. Organization of production
involves 1) drawing of resources from industries producing goods that
consumer's value more and 2) efficient use of resources by individual firms.
These refer to the constant channeling of resources away from firms
producing goods and services that consumers want most. Economic
efficiency, on the other hand, involves choices among the combination of
resources and the techniques that can be used in the production process.
3. output distribution
Distribution of the product output is accomplished by the price system

simultaneously with determination what is to be produced and the
organization of production. Those with larger incomes obtain larger shares of
the economy's output than those with smaller, modifications can be imposed
on the free enterprise economy without materially affecting the operation of
the price system. The price system will reorganize production to conform with
the new pattern of affective desires for goods and services.
4. rationing of goods in the very short run
An economic system must make some provision for rationing commodities

over the time period during which the supplies of these cannot be changed.
This time period is called the very short run. The economy must ration the
fixed supply in two ways: 1) it must allocate the supply among the different
consumers of the economy; 2) it must stretch the given supply over a certain
time period.
5. economic maintenance and growth
Every economy is expected to maintain and expand its productive capacity.

Maintenance refers to keeping the productive power of the economic
machine intact through provision for depreciation while expansion refers to
continuous increase in the kinds and quantities of the economy's resources,
together with continuous improvement in techniques of production.
NOTE: To determine how much you learn from the lessons presented, try to answer the
Practice Task 2 in the next page. After answering all the questions, compare your
answer to the Feedback to Practice Task.
 Practice Task 2
1. Illustrate and discuss briefly the circular flow model.
2. Enumerate the five function of an economic system.
a.
b.
c.
d.
e.
3. Differentiate economic maintenance from expansion.
NOTE: Compare your answer with feedback section of the practice task.
 Feedback to the Practice Task 2
1. The circular flow model
2) business receipts 1) costs of living

Money
Goods and Services
Business firms Households
Labor and Capital
Money (rents, wages, salaries, dividends, interest, etc.)

3) costs of production 4) consumers income
The circular flow model is generated from the decisions made by households and
firms about what and how much to produce out of the productive resources.
In this model, there are two economic units (households and business firms)
which interacts in two sets of markets (markets for consumer goods and services, and
resource markets). Households are the consumers of the economy's output of goods and
services while the business firms are ones engaged in buying and hiring of resources and
the production and sales of goods and services.
In this upper half of the figure (market for consumer goods and services) the
households as consumers and business firms as sellers goods and services flow from
business firms to consumers and a reverse flow of money from consumers to business
firms takes place. In the lower half of the figure (market for resources) the services of
labor and capital in their many forms flow from resource owners (households) to business
firms and a reverse flow of money in payment for these resources occurs in such forms as
wages, salaries, rents, dividends, interests, etc. money therefore, circulates continuously
from household to business firms and back to the households again. The money flow
takes on four familiar aspects as it makes a complete circuit. It is consumer's cost of
living at point (1) as it leaves consumers' hands. It is business receipts for business firms
at point (2). At point (3), the money flow becomes costs of production, while at point (4),
it is consumers' income.
2. the five functions of an economic system are:
a. determination of what to produce
b. organization of production
c. output distribution
d. rationing of goods in the very short run
e. economic maintenance and growth
3. Maintenance refers to keeping the productive power of the economic machine intact
through provision for depreciation while expansion refers to continuous increase in
the kinds and quantities of the economy's resources, together with continuous
improvement in techniques of production.
Did you get all the answers correctly/ if you did, CONGRATULATION!!! You
can now proceed to input 3 of this module.
If you missed some items in the test, read again the parts that you have not fully
understand

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 INPUT 2.

The Organization of an Economic System

In producing goods and services to satisfy consumer demands and to make

I. The Circular Flow Model

Goods and Services

Business firms Households

Labor and Capital

Money (rents, wages, salaries, dividends, interest, etc.)

II. The function of an Economic System

Every economic system must somehow perform five related functions:

1. determine of what to produce

This is a problem of determining what wants in the aggregate is most

An economic system must determine how resources are to be organized to

Distribution of the product output is accomplished by the price system

4. rationing of goods in the very short run

An economic system must make some provision for rationing commodities

5. economic maintenance and growth

Every economy is expected to maintain and expand its productive capacity.

1. Illustrate and discuss briefly the circular flow model.

2. Enumerate the five function of an economic system.

3. Differentiate economic maintenance from expansion.

1. The circular flow model

2) business receipts 1) costs of living

Goods and Services

Business firms Households

Labor and Capital

Money (rents, wages, salaries, dividends, interest, etc.)

a. determination of what to produce

d. rationing of goods in the very short run

e. economic maintenance and growth

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