Essential or Vital Processes of an economy mean those necessary economic activities without which an economy cannot exist or work.
The primary function of the economy is to provide goods and services for satisfying wants of the people.
The act of satisfying wants by the use of goods and services is called consumption. Production and consumption are, therefore, essential economic activities which must go on in an economy continually. But if the economy wants to maintain its existing productivity or increase its future productive capacity, it must consume less than what it currently produces. In other words, if the economy is to grow and expand, it must save something from its current production and this saving must be invested. Hence there are three essential processes of an economy, viz.,
Here we shall briefly introduce them.
For an economy to exist, production of goods and services is very essential. The standard of living or the consumption standard of the people depends, in the ultimate analysis, on the volume and variety of production. In fact, performance of an economy is judged by the level of its production. Richness or poverty of a country is dependent upon the amount of goods and services it is able to produce.
The process of growth or development consists in increasing the level of production in the economy. The United States of America is the richest country in the world and its people enjoy the highest living standards because its level of production is the highest. India is a poor country because its level of production is very low. In order to make India rich, we shall have to step up the rate of production in the, economy.
In Economics, by production we mean any economic activity which is directed to the satisfaction of the wants of the people. Whether it is the making of material goods or the provision of any service, it is included in production, provided it satisfies the wants of some people. Thus, in Economics, if making of cloth by industrial workers is production, the service of the retailer, who delivers it to the consumer, is also production.
This is so because the service done by the retailer is a part of the process of satisfying consumers’ wants just as much as the work done by the factory worker. Similarly, the work of doctors, lawyers, teachers, actors, dancers, etc., is productive, since the services provided by them satisfy the wants of those who pay for them.
Goods that are produced are of two types. One type of goods is called consumers’ goods. Consumers’ goods are those goods which are used by the consumers for direct satisfaction of their wants. Bread, clothes, shoes, tea, coca-cola, etc., are all examples of consumers’ goods. The second type of goods is known as producers’ goods. Producers’ goods are those goods which help in producing further goods. The producers’ goods do not satisfy the wants of the people directly but they satisfy their wants indirectly by helping in producing consumer goods.
The second essential economic activity is consumption. It is the quantity and quality of consumption which constitutes the standard of living of the people. Consumption is the act of satisfying one’s wants. That consumption is an essential process of an economy is obvious. Producers make goods in order to satisfy the consumption wants of the people. If no one consumes, no one will produce. Consumption is thus the end of all productive activity. Moreover, consumption along with investment determines the level of income and employment in the economy.
The late Lord Keynes, an eminent economist, showed that the level of national income and employment depends upon the level of aggregate effective demand. Consumption is one constituent of this aggregate demand. Changes in propensity to consume of the people will bring about changes in income and employment in the country.
All that an economy produces may not be consumed. In fact, an economy must consume less than what it produces if it wants to grow or develop. The excess of production over consumption in a year is called saving and this saving is invested in further production. Investment may be defined as “the addition made to the total stock of capital (including inventories) in a year.”
Investment can take two forms:
(a) inventory investment and
(b) fixed investment.
The economy may accumulate stocks of finished consumer goods, materials and ‘goods in process’ in a year. These stocks are called inventories. If the rate of production of goods and materials is greater than the rate of their consumption, there will be an increase in their inventories and inventory investment will be positive. On the other hand, if consumption is going on faster than production, there will be decrease in these inventories and it will be negative. The addition made to the total stock of finished goods, materials and ‘goods in process’ is called inventory investment.
The excess of production over consummation can also take another from which is called fixed investment. There are certain goods called ‘fixed capital’ as industrial machinery, plants, tools and implements, factory buildings, etc., which are not produced to satisfy the wants of the consumers directly. Instead, they are produced to serve as aids in the process of producing consumers’ goods. Addition made to the total stock of fixed capital in a year is known as fixed investment.
If the economy wants to grow, it has to step up its rate of net investment. Investment, or what is the same thing, capital formation, is an important determinant of economic growth and development. With the help of capital we can produce more consumer goods. The use of machinery, tools and implements in both industry and agriculture greatly increase productivity. Investment thus considerably adds to the productive capacity of the economy.
The level of investment also plays an important part in the determination of income and employment in the short run. Propensity to consume being stable in the short run, it is the level of investment on which depends the level of employment in the country. Fluctuations in economic activity or what are called business cycles are mainly due to fluctuations in investment. The higher the level of investment, the higher the level of income and employment in the country.