Basic Units of Economic Analysis
An institutional unit that can perform economic activities independently is called an economic entity.
Classification of Basic Economic Entity
Consumers, households, firms, and the government are the four basic entities of an economy because they perform the basic economic activities of production and consumption in an economy.
Consumers are the basic economic entities in an economy. They consume goods and services in the market. Generally, consumers consist of institutions, groups of individuals, and individuals. Hence, economists have replaced the concept of the consumer with that of households.
A household refers to a group of people living under a single roof and taking economic decisions jointly. Thus, a household is primarily a unit relating to consumption. Households are consumption units. The dual roles played by households are
- They purchase different consumer goods for self-consumption and pay prices for these goods.
- They are also the owners of different factors of production and sell these factors to firms. They earn factor income for supplying these factors.
Households and firms interact with each other in two kinds of markets. They are product markets and factor markets. When they interact in a market for factors of production, they are called factor markets.
A firm refers to a particular unit producing a commodity or service with a view to earning profit. The dual roles
played by firms are
- They produce and sell different products in exchange of product-prices.
- They purchase different factors of production by paying factor-prices to the owners of those factor services.
In this way, an exchange relationship is established between the firms and the households.
Certain goods and services are not produced by private firms, such as defense and home security which are provided by the government. Also, the government regulates the money supply and frames broad economic policies regarding domestic and international trade and taxation. The most important aim of the government is to maximize social welfare.
Differences between Fiscal Policy and Monetary Policy
|Fiscal policy affects the revenue and expenditure of the government.
|Monetary policy affects the aggregate supply of money in an economy.
|Fiscal policy instruments are government
expenditure, imposition of taxes, subsidy provision, and public debt.
|Monetary policy instruments are bank rate, statutory liquidity ratio, cash reserve ratio, and differential interest rates.