Circular Flow of Income in Two Sector Economy

Circular flow of income refers to the continuous flow of income and expenditure in an economy. It shows the interdependence of different sectors in an economy. In a two sector economy, there are only two sectors that are involved in the production and consumption of goods and services. These sectors are household and firms. The circular flow of income in a two sector economy can be explained as follows:

Situation Diagram:

The situation diagram for a two sector economy is given below:

Household Sector -->Firms Sector
^ | ^
| v |
Goods and Services Factor Payments

Explanation:

The above situation diagram shows the flow of goods and services and factor payments between the household and firms sector. The diagram consists of two sectors, household sector and firms sector, and two markets, goods and services market and factor market.

Goods and Services Market:
In the goods and services market, households are the buyers and firms are the sellers. Households purchase goods and services from firms, and firms receive revenue from households for the goods and services sold. This revenue is the source of income for the firms.

Factor Market:
In the factor market, firms are the buyers and households are the sellers. Firms purchase factors of production such as land, labor, capital, and entrepreneurship from households, and households receive payments for providing these factors of production. These factor payments are the source of income for households.

Circular Flow:
The circular flow of income starts with the production of goods and services by firms. Firms use factors of production such as land, labor, capital, and entrepreneurship to produce goods and services. These goods and services are sold to households in the goods and services market. Households pay for the goods and services, and the revenue generated from the sale of goods and services is the income of firms.

On the other hand, households provide factors of production to firms in the factor market. Firms pay for these factors of production, and the payments made by firms are the income of households. This income is used by households to purchase goods and services from firms in the goods and services market.

Conclusion:

In a two sector economy, the circular flow of income shows the interdependence of households and firms. Households provide factors of production to firms, and firms use these factors of production to produce goods and services. Households purchase goods and services from firms, and firms receive revenue from households for the goods and services sold. This circular flow of income continues as long as there is production and consumption of goods and services.

In two sector economy income and goods &services flow between households and firms. Households provide factors of production I.e. land, labour, capital and enterprise to the firms and in return the firms pays factor payment to the households. with the help of factors of production firm produces goods and provide services which is consumed by the households and for this consumption they pay factor payment to the firm