Question

Briefly explain the two sector circular flow model.

Answer 1

circular Flow of Income in a Two-Sector Economy:
There are only two sectors namely, the household sector and the firm sector.

1. Household Sector:

1. The household sector is the sole buyer of goods and services, and the sole supplier of factors of production, i.e., land, labour, capital, and organisation.
2. It spends its entire income on the purchase of goods and services produced by the business sector.
3. The household sector receives income from the firm sector by providing the factors of production owned by it.

2. Firms:

1. The firm sector generates its revenue by selling goods and services to the household sector.
2. It hires the factors of production, i.e., land, labour, capital and organisation, owned by the household sector.
3. The firm sector sells the entire output to households.
4. In a two-sector economy, production and sales are equal and there will be a circular flow of income and goods.
5. The outer circle represents real flow (factors and goods) and the inner circle represents the monetary flow (factor prices and commodity prices).
6. Real flow indicates the factor services flow from the household sector to the business sector, and goods and services flow from the business sector to the household.
7. The basic identities of the two-sector economy are as under:

Y = C + 1
Where
Y is Income; C is Consumption; I is an investment.