Question

State the equilibrium condition of circular flow in a two-sector economy.

Answer 1

In a two-sector economy (comprising only households and firms, with no government or foreign trade), the equilibrium condition is S = I.

Where:

S = Savings by households

I = Investment by firms

Equilibrium occurs when households' total savings (S) equal enterprises' investment expenditure (I). This ensures that every income generated is spent or invested, resulting in a consistent circular flow of income.