Answer the following question.
With the help of a diagram, show the circular flow of income in a two-sector model with Savings and Investment.
Solution
In Fig. we have considered a two-sector economy with households and firms. It is assumed that the household sector and producing sector do not save at all. However, in reality, households save a portion of their income for many reasons like precautionary purposes, transaction purposes, etc. On the other way, they borrow money from the capital market for both development and as well as for even non-development purposes. Similarly, firms also save some part of their receipts for the expansion of business, transactional purposes, speculative purposes, precautionary purposes, etc. Moreover, the firms also collect loans (i.e., investment) from both banks and non-banking financial institutions to generate capital in their business. Thus, the inclusion of saving (Leakage, i.e., an outflow of income) and investment (Injection, i.e., the inflow of income) in the two-sector economy with the capital market as shown in the Fig. have made the two-sector economy more meaningful and modernized.
