Question

Elaborate the two components of Aggregate Supply in a two-sector economy.

Hint:

In a two-sector economy, Aggregate Supply (AS) is the sum of Consumption (C) and Savings (S).

Answer 1

In a two-sector economy (comprising only households and firms), Aggregate Supply (AS) represents the total output produced in an economy. The two main components of Aggregate Supply (AS) are: 1. Consumption (C):
- Households spend a part of their income on consumption of goods and services.
- This is known as induced consumption, as it varies with the level of income.
- It is represented as: \[ C = C_0 + MPC \times Y \] where \( C_0 \) is autonomous consumption, and \( MPC \) is the Marginal Propensity to Consume. 2. Saving (S):
- The part of income that is not consumed is saved for future needs.
- Saving is an essential component of aggregate supply as it provides funds for investment in the economy.
- It is represented as: \[ S = Y - C \] Conclusion: In a two-sector economy, aggregate supply (AS) is equal to national income (Y) and consists of Consumption (C) and Savings (S): \[ AS = C + S \]