How do firms and households interact in the economy?

Fsp Invest, 08 Jan. 2014

Tags: economy, economic activity, flow of economy activity, where does the money that makes up the economy come from, roles of firms and households in the economy, how are investment funds used by firms,

If you want to understand where the money that makes up an economy — and your investments — comes from, you need to understand the flows of economic activity that are going on all the time. Let’s take a look at the roles firms and households play in the economy and how they generate the funds YOU end up investing in the stock market.

The first thing you need to know is that in its simplest form, the economy consists of two groups: Firms and households. 

Households provide labour to firms. 

Firms provide goods and services and supply them to households for consumption. 

Corresponding to these flows of resources, are financial or cash flows. 

Firms pay households for their labour, and households pay firms for goods and services. 
In reality, the economy is a little more complicated
Leakages from this circular flow also exist, including savings, imports and taxes…
Injections into the circular flow also exist, notably investment spending…
So your investment spending is an important part of the economy! 
Because it helps generate income for firms that then use that money to produce more goods and services. 
So there you have it, that’s what’s happening in the economy when you invest your money. 

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