Firms and households

Producers and consumers

In national accounts, economic agents are classified according to their role. Schematically, they can be classified into two main groups: producers and consumers. Producers are in charge of the creation of goods and services, consumers destroy the goods and services produced to satisfy their needs. The main producers are firms and the main consumers are households.

Principle: The producer is the economic agent who becomes the owner of the goods and services at the time they are produced.

Indeed, national accounts do not define the producer as an economic agent who physically participates in activity of production but as the economic agent who becomes the owner of the products at the time of their creation. For example, an employee is never considered a producer. However, if the employee changes his legal status by creating business and continues to work for his former employer as a provider of services, he becomes a producer even if there is no change in his concrete work. His output is an intermediate consumption of the company that uses it.

Since goods and services belong to producers at the time they are produced, consumers must buy them to be able to consume them. For this, they can use the money they have, but as this money is not inexhaustible, the economy cannot durably function without transfers from producers to consumers. Such transfers must be decided by mutual agreement to be recorded in the system of national accounts.

Accounts

To describe the accounts of economic agents, let us consider a simplified economy composed of a single firm and a single household. In accordance with the accounting tradition, an account of an agent consists of two columns, the right column taking the name of "resources" and the left one of "uses".

The account of an economic agent records its transactions, i.e. flows affecting the level or the composition of its wealth.

Transaction affecting the level of wealth

For an economic agent, there are only two possibilities to increase the level of its wealth:

• to produce goods and services;
• to receive transfers from another agent;

During the current period, this increase of wealth can be used in two ways:

• it can be consumed, i.e. destroyed;
• it can be accumulated, i.e. kept for later use.

For each agent, accounts can show the increase in its wealth and its uses. The right column of the account which is called "resources" shows the origin of the increase in wealth, the left column which is called "uses" shows its uses.

If there were only one agent, its account would be as follows:

If there are two agents, a firm and a household, the consumption of the firm corresponds to intermediate consumption and the consumption of the household to final consumption. The firm and the household have to share the global accumulation. The accounts are as follows:

But the household must acquire health before consuming or accumulating it. Since a household cannot create wealth, the only means for him is to receive transfers from the firm. Therefore the accounts are:

Transactions affecting the composition of wealth:

Wealth is composed of assets that are stores of value. The system of accounts distinguishes three main categories of assets:

• Produced assets: goods and services;
• Non produced assets, for example land;
• Financial assets, for example money, loans and credits.

An economic agent can modify the composition of its wealth by exchanging its assets against other assets. However, national accounts do no record these exchanges but only the accumulation of the different types of assets, i.e. the acquisitions less the disposals of these assets.

The accumulation of goods and services corresponds to gross fixed capital (GFCF) and changes in inventories.

Since it is not possible to create non produced assets, their accumulation is globally nil and the acquisition of a non produced asset by an agent is necessarily balanced by a disposal of another agent.

Financial assets are the counterparts of liabilities and the creation of a financial asset does not correspond to an increase in wealth. For example a loan corresponds to a creation of a liability for the borrower and to an acquisition of asset for the lender. But the creation of a liability for the borrower is balanced by an acquisition of money and the acquisition of a financial asset by the lender is balanced by a disposal of money. Money itself is a financial asset that corresponds to liabilities for banks.

Globally, the changes in liabilities are equal to the changes in financial assets:

But, but for an agent it is not necessarily the case since it can exchange a financial asset against another type of asset. However, globally the equality is still respected:

Therefore, an economic agent can increase its stock of assets by increasing its liabilities. The accounts of the firm and the household become:

Now, it is possible to breakdown the accumulation of the agents by type of assets. For a household without any production activity, GFCF and changes in inventories are nil, therefore the accounts of the firm and the household are:

The account of a firm

In the account of a firm, output and changes in liabilities are recorded as resources because they are a means to increase the assets of the firm. The various uses of the increase in assets are described in "uses":

• destruction of assets:
  • intermediate consumption;
• distribution of assets:
  • transfers paid;
• accumulation of assets:
  • gross fixed capital (produced assets);
  • changes in inventories (produced assets);
  • changes in non-produced assets;
  • changes in financial assets.

The tansfers paid by the firm to households can be classified in three main types :

• wages paid to employees;
• interests paid to lenders ;
• dividends paid to the shareholders.

An example of simplified version of the account of the firm is as follows :

The account of a household

The transfers received from the firm and the increase in liabilities are recorded in resources because they are a means to increase the stock of assets. The various uses of the increase in assets, i.e. the final consumption, the changes in non-produced-assets and the changes in financial assets,are recorded in uses.

An example of a simplified version of the account of a household is as follows:

Integrated economic accounts

The account of the firm and the account of the household are closely linked and it is useful to integrate the two accounts in a same table, the integrated economic accounts. A simplified version of this table is as follows:
 

This table is balanced in columns because each agent account the total resources are equal to total employment. The table is also balanced for the rows describing transfers since for each transfer received by an agent corresponds a transfer paid by another agent. The rows describing the changes in financial assets are also balanced since for each financial asset, a change for one agent is always balanced, either by an opposite change in this asset, or by a change in liabilities.

However, the rows related to goods and services are not balanced since output is only recorded in resources and other transactions in products are only recorded in uses.

To balance the rows, the goods and services account is introduced in the table. Since output is on the right side of the table, it must appear in the left column of the account of goods and services. Similarly, intermediate consumption, final consumption, gross fixed capital and changes in inventories must appear in the right column of the goods and services accounts. So, the goods and services accounts is a mirror account, which explains that, contrary other accounts, he describes resources in the left column and uses in the right column.
 

Balancing items

It is useful to break down an account in several accounts to present explicitely certain important values. For example, we have seen that one of the aim of national accounts is to study the creation of wealth, therefore it is interesting to explicitly show the increase of wealth of each economic agent. Since the increase of wealth of an agent corresponds to its accumulation, we can group in a specific account all the accumulation transactions. As it is also important to keep the global consistency of the accounts, the best way is to break down the accounts of the economic agents in two parts: one part corresponding to accumulation transactions and one part corresponding to other transactions. For example, the account of the firm can be broken down as follows:

We can note that the sub-accounts are not balanced because the total of resource is not equal to the total of uses. To balance the sub-accounts it is necessary to introduce a balancing iem that is saving. This balancing item balances both the two accounts.

The balancing item of the first sub-account is equal to S = C − A, it is also the balancing item of the second sub-account because C − A = B − D.

Saving measures the increase in wealth of an economic agent because it is equal to the difference between changes in assets and changes in liabilities.

It is preferable to change the heading of the second sub-account to explicitly show the meaning of the transactions recorded in it. So, "uses" is replaced by "changes in assets" and "resources" is replaced by "changes in liabilities and net worth". The term "net worh" is added to take account the balancing item.

It is also possible to show the wealth actually created by the firm. This wealth is called "value added" and it is equal to the difference between the wealth created and the wealth destroyed by the production process, i.e. the difference between output and intermediate consumption. It is possible to introduce the value added in the accounts by dividing the first sub-account in two sub-accounts as follows:

The second sub-account can also be broken down into two sub-accounts in order to distinguish between changes in financial assets and changes in non-financial assets. The corresponding balancing item is called "net lending / net borrowing". Net lending corresponds to a positive value and net borrowing to a negative value.

We can incorporate these balancing items in the integrated economic accounts.

Property: The sum of the net lending / net borrowing of all the economic agents is zero.

Indeed, since net lending is the balance of the last sub-account, for each agent:

Net lending + changes in liabilities = change in financial assets

If we sum this equality over all agents:

Σ Net lending + Σ Changes in liabilities = Σ Changes in financial assets

But each change in liabilities is balanced by a change in financial assets, so that the sum of the changes in liabilities is equal to the sum of changes in financial assets. Therefore, the total net lending / net borrowing is zero.

This text only reflects the opinion of its author: Francis Malherbe