The capitalist economy and its four sectors

The economy we study is a capitalist economy. Its features:

• the means of production (land, machines, factories) are privately owned;
• production is for sale in the market, not for one's own use;
• labour is bought and sold for a wage.

A family farm that grows rice mainly for its own use, with family labour, is not capitalist production.

Entrepreneurs combine the four factors of production: land, labour, capital and their own entrepreneurship. From their revenue they pay rent for land, wages for labour and interest for capital. What is left is profit. When profit is spent on new machines and factories, raising the economy's capacity to produce, that is investment expenditure.

The economy has four sectors:

• Households: they consume, save, pay taxes, and supply the factors of production.
• Firms: they produce goods and services.
• Government: it makes laws, collects taxes, and spends on public works and services.
• External sector (rest of the world): exports (selling abroad), imports (buying from abroad), and flows of capital.