Question

Identify the correct statement in the context of Circular Flow of Income in a two-sector economy:

• A. Household receives factor services from firms
• B. Household invests while firm saves
• C. Firms produce goods and services
• D. Household supplies factor services to Government

Answer 1

The Correct Option is C

In a two-sector economy, the Circular Flow of Income describes the movement of money between households and firms. The correct understanding involves recognizing the roles of these entities: 

• Households: They supply factor services such as labor, land, and capital to firms and in return receive income in the form of wages, rent, and profits.
• Firms: They utilize these factor services provided by households to produce goods and services. These goods are then sold back to the households, creating a flow of income and expenditure.

Given this framework, the most accurate statement related to the Circular Flow of Income in a two-sector economy is:

• Firms produce goods and services

This statement accurately reflects the interaction between households and firms where firms play the role of producers in the economy.

Answer 2

In a two-sector economy, there are only two key economic agents: firms and households. Firms are responsible for producing goods and services that are sold in the market, while households provide labor and other factors of production, such as land, capital, and entrepreneurship, to the firms.

The interaction between these two sectors forms the basis of a simple economic model. Households supply their labor and other resources to firms in exchange for income, typically in the form of wages, rents, and profits. This income is then spent by households on the goods and services produced by the firms, creating a circular flow of money within the economy.

In this model, the economy’s output is determined by the productive capacity of the firms, while the consumption decisions of households influence the demand for goods and services. This basic structure helps economists analyze economic behavior in a simplified way, though more complex models typically involve additional sectors like government and foreign trade.