Read this article to learn about the meaning, basic activities and sectors of economy of a country!

Meaning of an Economy:

“Economy is a system by which people get their living.”—Professor A.G. Brown.

A system consists of several independent parts. Therefore, an economy consists of all such institutions which provide employment or livelihood to the people. Production generates income. For every rupee’s worth of goods and services produced, income of a rupee is generated. Production of goods and services takes place in different ways.

For instance, production is undertaken in farms, factories, mines, shops, banks, railways, roads, workshops, schools, hospitals, cinema halls, ships, airlines, government and private offices, etc. All these institutions which produce goods and services and thus provide a living (or Income) to the people are collectively called an economy.


Alternatively, we can say that economy is the collection of producing units located within a geographical area of a country. That is why we have Indian economy, American economy, British economy, Russian or Chinese economy which indicate the collection of all the producing units (or income generating units) located within the geographical boundaries of the countries concerned.

Basic Activities—Production, Consumption, and Capital Formation:

An economy represents the sum total of economic activities in a country. The basic function of every economy is to provide a living to the people for satisfaction of their wants. For this purpose, all economies perform some basic activities which are grouped under three heads, namely, production, consumption and investment, as explained below. These basic economic activities are also called three vital processes of the economy because they are vital for the economy to survive and grow.

(a) Production:

Production is generally defined as an activity which produces material goods and services or which Increases the value of commodities already produced. Simply put, any activity which results in value added is defined as production. Suppose a carpenter purchases plain wood worth Rs 10,000 from timber market and out of it makes furniture which he sells for Rs 17,000. Clearly, the value added by the carpenter is Rs 7,000 (= 17,000 – 10,000).


This is called production by the carpenter who has added value to the already existing good (i.e., plain wood) by converting input (plain wood) into output (furniture). So is the case with a weaver who makes cloth from raw cotton or a miller who converts wheat into flour or a jeweler who makes bangles from gold.

Production includes not only creation of material goods but rendering of services also because like physical goods, services also satisfy human wants. For instance, doctors, teachers, accountants, managers. Judges, Chowkidars, office-clerks, transporters, electricians, mechanics, coolies, etc. who add value by rendering their services and earn incomes, are treated as producers.

(b) Consumption:

“The process of using up of goods and services for direct satisfaction of individual or collective human wants” is called consumption. The households purchase a large number of goods such as food grains, milk, ghee, soaps, cloth, shoes, cycles, furniture, fridges, TV sets, etc. and services like those of doctors, teachers, banks. Insurance companies, transport, etc. to satisfy individual wants.


In short, all purchases except that of houses by the households are called household consumption. Mind, in national accounting houses are treated capital goods instead of consumer goods as an exception since a house continues to produce housing services almost throughout the life of its owner. Again, all goods—durable or non-durable—are treated as consumed the moment they are purchased/acquired by the households (consumers).

Similarly, gifts received by the households in the form of goods are also treated as consumed the moment they are received. Collective human wants like roads, parks, schools, hospitals, defence, law and order are met by government which provides these services either free or at nominal price. Use of these services by the people is called collective consumption or government consumption.

(c) Capital Formation (Investment):

Besides production and consumption, capital formation is the third important function of an economy. “Capital formation is the net addition to the capital stock of an economy during a given period.” In a growing economy, all that is produced in a year is not consumed usually. And that part of production which is not consumed during a year is investment. In other words, excess of production over consumption is called capital formation or investment.

Alternatively, that part of current production, which is not consumed but set aside for use in future production, is called capital formation. This surplus results in accumulation of goods which is added to the stock of capital thereby increasing the productive capacity of the economy. Thus, capital formation involves making of more capital goods like machines, factories, transport equipment, etc. which are used for further productions of goods.

Inter-relationship between basic activities of an economy is clear. Increase in production leads to increase in consumption or capital formation or both. If whole of production is consumed, there will be no capital formation and production capacity will start decreasing. Thus, these three activities are interrelated.

Sectors of an Economy:

In India, a government agency named Central Statistical Organisation (CSO), which computes official estimates of national income and related aggregates, has divided the entire economy into following three sectors. Broadly, primary sector exploits natural resources.

Secondary sector transforms one type of commodity into another and tertiary sector renders services as explained below:

(i) Primary sector (also called Agricultural sector):


This sector includes all production units which produce goods by exploiting natural resources. These include resources like water, forests, agricultural land, coal, iron ore and other minerals, etc. Thus, this sector consists of man’s primary occupations such as farming, fishing, mining, etc. This sector supplies basic raw material to secondary sector.

(ii) Secondary sector (also called Manufacturing sector):

This sector includes all production units which are engaged in producing goods by transforming raw material (received from primary sector) into finished products or one type of commodity into another type of commodity. Examples are cloth mills, sugar mills, steel Industry, shoe factory, biscuit factory, construction, power generation, etc.

(iii) Tertiary sector (also called Service sector):


This sector consists of producing units which are engaged in producing services. For example, banks, transport companies, insurance companies, educational and medical institutions, hotels, restaurants, government administration, etc. Thus, tertiary sector provides useful services to the other two sectors.