Circular Flow Model in Two Sector Economy

In two sector circular model, there are household and business sector. There is absence of government. The household sector is source of factors of production like land, labor and capital. Business sector is the source of goods and services.

Assumptions:

a)     There are only two sectors in the economy i.e. household and business.

b)     Household spend all its income on consumption i.e. there is no saving.

c)     Firms are able to produce exact quantity of goods and services which household sector demands.

d)     There is no government intervention.

e)     Business sector do not carry out any import or export quantities.

There are two circles in the circular flow model. The inner circle represents the monetary flow and the outer circle represent the real flow.

a. Real Flow

It indicates the flow of factors of production from household sector to the business sector for producing goods and services and flow of goods and sectors from business sector to the household sectors for consumption.

b. Monetary flow

It indicates the flow of rent, wage, interest and profit to the household sector from business sector to the household sector for hiring factors of production. On the other hand, the consumption payment flows from household sector to the business sector for consuming goods and services.