Question

“In a two-sector economy, consumption expenditure by households is always equal to aggregate expenditure on goods and services produced by the firms.”
Do you agree with the given statement? Support your answer with valid explanation.

Hint:

In a two-sector model (closed economy without savings or government), income flows in a circular way — from households to firms and back again — ensuring equality between income and expenditure.

Answer 1

Yes, in the context of a simple two-sector economy — consisting only of households and firms — the statement is true. Here's how:
In such an economy, households provide factors of production (like land, labour, capital, and entrepreneurship) to firms.
Firms use these factors to produce goods and services, and pay households in the form of factor incomes (wages, rent, interest, profit).
Households use this income entirely for consumption — there is no saving, government, or foreign trade sector in this model.
Firms, in turn, receive this income back when households buy their goods and services.
Thus, all income earned by households is spent on consumption, and all production by firms is matched by household consumption. Therefore, in equilibrium: \[ \text{Aggregate Expenditure (AE)} = \text{Consumption Expenditure (C)} = \text{Value of Output} \]