Circular flow of income in a two sector economy refers to the flow of goods and services and the corresponding flow of income between the households and the firms in an economy. In a two sector economy, there are two main sectors: households and firms. Households provide factors of production, such as labor, land, and capital, to firms, which in turn use these factors to produce goods and services. The households then receive income in exchange for their factors of production, which they use to purchase goods and services from the firms. This creates a circular flow of income in the economy.

Factors of Production

The circular flow of income starts with the households providing factors of production to firms. Factors of production refer to the resources that firms use to produce goods and services. These factors include labor, land, capital, and entrepreneurship. The households provide these factors in exchange for income.

Production

The firms use the factors of production to produce goods and services. These goods and services are then sold to the households and other firms in the economy.

Income

The households receive income in exchange for providing factors of production to the firms. This income can be in the form of wages, rent, interest, and profits. The households use this income to purchase goods and services from the firms.

Expenditure

The households purchase goods and services from the firms using their income. This creates expenditure in the economy. The firms use the revenue from these sales to pay for the factors of production and to make a profit.

Circular Flow

The circular flow of income is completed when the firms use their revenue to pay for the factors of production and to make a profit. The households then provide factors of production to the firms in exchange for income, and the cycle starts again.

In conclusion, the circular flow of income in a two sector economy involves the flow of goods and services and the corresponding flow of income between households and firms. The households provide factors of production to firms and receive income in exchange, which they use to purchase goods and services from the firms. This creates a circular flow of income in the economy.