(This post is a part of the series on Basics of Finance and Investing.)

It helps to know the main components of a financial world, the forces they exert and the interests they represent. There are three major players: household sector, business sector and government sector.

Household sector

This is the human component of an investing environment, people like you and me, the individual investors. We work and earn income in return for our services. We spend part of the income to meet our consumption needs, and invest the rest to support ourself after retirement. Tax and risk aversion are the two major concerns that shape our investment choices and decisions.

Business sector

The household sector wants to invest the “excess” fund, whereas the business sector needs fund to finance their real assets (technology, wages for employees, and so on). They acquire funds by, (1) borrowing from the household (indirectly via banks, or directly by issuing corporate bonds), and, (2) forming “partnership” with investors (by issuing ownership stakes in terms of company stocks).

Government sector

The government also needs fund (to run itself, of course). But, unlike the business sector, they cannot invite partners by issuing a “government stock”. The government has a direct funding source by imposing tax on our income. They also own printing press, and can print currency if needed (raises inflation concern though). When tax revenue is not enough, the government borrows fund by issuing securities such as treasury bonds, notes and bills.

Demand-Supply chain

Thus, in a financial world, the household sector constitutes the supply end of the money chain, whereas the business and government sectors make the demand end of it. The other half of the chain that completes the full circle, where households get their money (from the other two sectors) as income for services rendered, lies outside of the investing environment.

See related posts:

1. Banks, Investment companies and Investment banks
2. What determines the "real" interest rate?
3. What is a "bond"?