*Day #02 28.03.2020*
*CIRCULAR FLOW OF ECONOMY TWO SECTOR ECONOMY*
*MEANING -*
It refers to cycle of generation of income in the production process, its
distribution among the factors of production and finally, its circulation from
household to firms in the form of consumption expenditure on goods and services
produced by them.
*PHASES –*
1- Generation Phase – Production
of goods and services with help of factors of production.
2- Distribution Phase – Flow
of factor income (Rent, Interest, Wages, and Profit) from firms to household.
3- Disposition Phase –
Income received by household, spent on the goods and services produced by
firms.
*Assumption
-*
1. The two
sector economy has the following assumptions
2. There
are only two sectors in the economy; household sector and business sector
3. No
government interventions over the economic activities
4. Business
sectors do not carry out any import or export activities, creating a closed
economy
*On
the basis of the assumptions, the two sector economy is explained with the help
of the following diagram*
* There are two sector in the economy; Households
and firms. It means no Govt. and no foreign sector.
* Household supplies factor services (i.e. Land,
Labour, Capital and Entrepreneur) to Firms.
* Firms produce goods and services and sell their
entire product to household sector.
* Household receive factor income (i.e. Rent, Wages,
Interest and Profit) for their services and spend the entire amount on
consumption of goods and services.
Since the households spend
their income, the total monetary receipts of business sector will be equal to
the income and consumption expenditure of the household sector. This
means, monetary receipts of the producers =
income of the households = consumption expenditure of the households. In
this way, an equilibrium state exists in the economy where total demand equals
total supply.
Thus the circular movement of
income and expenditure in the economy continues, leading to equalization in the
gross national product and gross national income.
*With Financial Market -*
If the Financial market (Banks, Insurance companies etc, which transact in loan
able funds) available in the economy. The households will deposits their
savings in banks and same as firms also will deposits their savings in bank. On
the other hands firms also borrow money from the banks to finance their
expansion programmes.
REAL FLOW
* It refers to the flow of factor services from
households to firms and the corresponding flow of goods and services from firms
to house hold.
* It Involves exchange of goods and services.
* There may be difficulties of barter system in
exchange of goods and factor services.
* It is also known as Physical flow.
MONEY FLOW
* It is the flow of money between firms and
households.
* It is also known as Nominal flow.
*QUESTIONS AND ANSWERS*
*1. Match the following:*
Contribution made factors of production
|
Remuneration
|
(1) Human labour (b)
|
(a) Rent
|
(2) Capital (c)
|
(b) Wage
|
(3) Fixed natural resources (called Land) (a)
|
(c) Interest
|
(4) Entreprenurship (d)
|
(d) Profit
|
*2*. In a two sector economy, in which of the following way the
households may dispose off their entire earning or Income? (Choose the correct
alternative)
(a) Spending on the goods and services produced by the domestic firms.
(b) Payment of taxes to the government.
(c) To buy imported goods.
(d) Savings.
*3.* Flow of factor payments and payments for goods and services between
households and firms is called ______. Fill in the blanks.
*4.* Who earns money and spends their income on goods and
services?
(a)
Firms
(b)
Business
(c)
Households
(d)
Schools
*5.* What is the role of firms in the circular flow of
income?
(a)
To purchase goods
(b)
To produce Goods
(c)
To earn income through wages
(d)
To provide capitals
*6.* What is an expenditure?
(a)
Land
(b)
Labour
(c)
Schools
(d)
Money
*HOTS - Analyzing, Evaluating & Creating Type Questions*
*Question - “Circular flow of income in a two sector economy is based
oon the axiom that one’s expenditure is other’s income.” Do you agree with the
given statement? Support your answer with valid reason.*
Answer – Yes, the given statement it correct. In a two sector
economy, the firms produce goods and services and make factors payments to the
households. The factor income earned by the households will be used to buy the
goods and services which would be equal to income of firms. The aggregate
consumption expenditure by households in the economy is equal to the aggregate
expenditure on goods and services produced by the firms in the economy. (Income
of the producers)
*Question
- What
is circular flow of income in two sector economy?*
Answer - The circular flow model in the two-sector
economy is a hypothetical concept which states that there are
only two sectors in the economy, household sector and
business sector (business firms). The household sector is
the source of factors of production who earn by providing factor services to
the business sector.
*Question
- What
are the two main flows in an economy?*
Answer - Production, consumption and exchange are the
three main activities of the economy. Consumption and production
are flows which operate simultaneously and are interrelated and
interdependent. Production leads to consumption and consumption necessitates
production.
*Question
- How
the flow of income is circular?*
Answer - The circular flow of income or circular
flow is a model of the economy in which the major exchanges are
represented as flows of money, goods and services, etc. between
economic agents. The flows of money and goods exchanged in a closed
circuit correspond in value, but run in the opposite direction.
*Question
- What
are the two basic principles of circular flow of income?*
Answer - The circular flow of income involves two
basic principles:
(ii) Goods and
services flow in one direction and the money payment to acquire
them, flow in the return direction giving rise to a circular
flow.
*Question
- What
is the flow of money?*
Answer - Key Takeaways. Money flows depict the way
that money and credit circulate in the economy as income turns into
savings and investment and back again. Real flows depict the way that
commodities and products & services are produced and consumed in the
economy.
*Question
- What
do you mean by real flow and money flow?*
Answer - Money flow and real flow are the two main
aspects of the circular flow of income economic model. Real
flows refer to the flow of the actual goods or services,
while money flows refer to the payments for the services (wages, for
example) or consumption payments
*Question
- What
is meant by the physical flow of goods?*
Answer - What is meant by the physical flow of goods?
The physical flow of goods involves the movement
of goods and services from the business sector to the household
sector and vice versa.
*Question
- What
is nominal flow?*
Answer - Money flow or nominal flow refers to
the flow of factor payments from firms to households for their factor
services and the corresponding flow of money from households to
firms, in the form of consumption expenditure on the purchase of goods and
services produced by the firms
Online Class for XII
Video #02
Day #02 - 28.03.2020
Concept of Circular Flow of Income
Online Class for XII
Video #03
Day #02 - 28.03.2020
Concept of Real Flow and Money Flow
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Regards
Dr. Asad Ahmad
KV IIM, Lucknow
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Dr. Asad Ahmad
PGT Eco
KV IIM, Lucknow
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