Question

Discuss briefly the concept of circular flow of income in a two-sector model.

Hint:

The two-sector model assumes no government or foreign sector, making it a simplified representation of real-world economic activities.

Answer 1

Understanding the Two-Sector Model:
The two-sector model of the circular flow of income includes only two economic agents:
1. Households – who provide factors of production (land, labor, capital, and entrepreneurship) and receive income in return.
2. Firms – who produce goods and services and pay households for factor services.
Circular Flow Explanation:
- Households provide factor services (labor, land, etc.) to firms in exchange for wages, rent, interest, and profits.
- Firms use these factor inputs to produce goods and services, which are then sold to households.
- The income earned by households is spent on consumption, leading to a continuous flow of income and expenditure in the economy.
Conclusion: This model demonstrates how income circulates within an economy, ensuring a balance between production, income, and expenditure.