And this makes the counter flow of factor pavements in the form of rent, wages, interest, and profit to the household sector from the business sector as monetary flow. In the upper half of the figure, there is the flow of factors of production from the household sector to the business sector as a real flow. That means real flow and money flow move in opposite directions in the case of the two-sector circular flow model. From the figure, it is clear that factor services and money flow in the opposite direction. The diagram is showing the continuous circular flow of income and expenditure in a two-sector economy. The financial sector only plays the role of intermediary to convert the savings of the household into investment.īased on the above assumptions, the two-sector circular flow model can be further explained with help of the following diagram.Households are the owner of factors of production.There is an absence of import and export by the business sectors.No government interventions over the economic activities.There are only two sectors in the economy: the household sector and the business sector.Two Sector Circular Flow Model: Assumptions The circular process begins with the flow of economic resources from households to firms to produce and the flow of money to households in the form of factor income and again money flows from households to firms as consumption expenditure made by the households. The business sector refers to the firms that produce goods and services and receive income by supplying the produced goods to the household sector. The household sector is the source of factors of production that earn by providing factor services to the business sector.
The circular flow model in the two-sector closed economy is a hypothetical concept that states that there are only two sectors in the economy, the household sector, and the business sector (business firms).
The flow of goods and services as well as factors between household, business, government, and foreign sectors. Types of Flows in Circular Flow Model The Physical/Real Flow
Business Sector: Responsible for investment expenditure-Production.Household Sector: Responsible for consumption expenditure- Consumption.Major Sectors/Actors in the Circular Flow Model It shows the flow of money, goods, and services, and factors of production through the economy.” – Paul Krugman. “A circular flow diagram is a simplified representation of the macroeconomy. It shows the regular flow of products, factors, and money received and paid among the household, business, government, and foreign sectors through the product, resource/factor, and financial markets. In another word, the circular flow of economic activities is defined as the flow of payments and receipts for goods and services, and factor services between different sectors/actors/agents of an economy. The circular flow is an economic model or tool used to show the continuous movement of output and input/factors of production, money payment, and received in buying and selling of output and inputs between producers, resource suppliers, and consumers. These flows of products, factor inputs, payment for products, and payment for factors of production create a macroeconomic circular flow model. In carrying out such economic activities there are different flows like the flow of goods and services, factors of production, factor payment, payment for goods and services, etc. It means consumers are involved in buying goods and services, producers are producing and selling goods and services, and the government is there to become part of such transactions, as well as for control mechanisms. The economy is a system in which all the economic agents are interdependently working and doing their respective economic activities.
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