Draw a diagram and explain how circular flow of income and expenditure take place
Answers
Circular Flow of Income in a 2-Sector Economy:
In a closed, 2-sector economy, two sectors exist
- Households
- Firms
A closed economy is an economy where the government sector doesn't exist and the economy has no relations with the rest of the world, which means no foreign sector.
The household sector is the owner of the factors of production- land, labour, capital and entrepreneur.
Households render their factor services to firms and in return, the firms give them factor payments (wages/salary).
The households then spend the entire amount as consumption expenditure to buy the goods they produced.
It is assumed that there are NO SAVINGS.
In return of consumption expenditure, the firms give the goods/services to the households and the circular flow of income becomes complete.
More to Know:
This concept involves 'flow', a dynamic concept that measures a variable over a period of time. It is of two types
- Real Flow: The flow of goods and services from households to firms or firms to households.
- Money Flow The flow of money between firms and households.
