Question

Explain the concept of circular flow of income in a two-sector economy.

Hint:

In a two-sector model, households provide factors of production, and firms produce goods, creating a continuous income flow.

Answer 1

The circular flow of income in a two-sector economy refers to the continuous movement of goods, services, and money between households and firms. Key Components:
1. Households: Own the factors of production (land, labor, capital, and entrepreneurship) and provide them to firms.
2. Firms: Use these factors to produce goods and services, generating income in the form of wages, rent, interest, and profit. Flow of Income:
- Households receive factor payments from firms and use their income to purchase goods and services.
- Firms receive revenue from sales, which they use to pay for factor inputs. Conclusion: In a two-sector economy, the income generated by production is fully circulated between households and firms, ensuring a balanced economic system.