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Question
Read the below case and answer the question that follow:
Circular Income Flow in a Two Sector Economy: In the figure given we can see that upper loop shows the resources such as land, capital and entrepreneurial ability flow from households to firms in the direction shown by the arrow direction.
The money flows from firms to the households as factor payments in the form of wages, rent, interest and profits, shown by the arrow direction.
The lower part of the figure shows the flow of money from households to firms in the form of consumption expenditure done by the households to purchase the goods and services produced by the firms, making the flow of goods and services from firms to households.
Thus, we see that money flows from business firms to households as factor payments and then it flows from households to firms. Thus, there is, in fact, a circular flow of money or income. This is how the economy functions.
Which of the following is not an assumption of a two sector model of Circular Flow of Income?
Options
Domestic economy comprises only 2 sectors, the producers and the households.
The households spend their entire income, so that there is no saving.
Domestic economy is an open economy (no exports and imports).
There is no government in the economy.
Solution
Domestic economy is an open economy (no exports and imports).
Explanation:
The following assumptions apply to the two-sector economy:
- No government interventions over the economic activities.
- Business sectors do not carry out any import or export activities, creating a closed economy.
- There are only two sectors in the economy; household sector and business sector.