An economic system consists of two main sectors between which funds a…

An economic system consists of two main sectors between which funds are mobilised. Which are these two sectors?

Answer & explanation

Correct answer: option 1

The correct answer is Option (1) → Households and business firms

Option (1) Households and business firms — Correct. Households save funds and business firms invest these funds. These are the two main sectors, and the financial market moves funds between them.

Option (2) Banks and financial markets — Incorrect. These are the two channels through which funds are allocated. They stand between the two sectors as competing intermediaries.

Option (3) Households and banks — Incorrect. Households are a sector, but banks are a channel. Banks take household deposits and lend them to business firms.

Option (4) Financial markets and business firms — Incorrect. Business firms are a sector, but a financial market is a channel. Through it, households buy the shares and debentures offered by firms.

NCERT (Pre-rationalised Edition): “CONCEPT OF FINANCIAL MARKET A business is a part of an economic system that consists of two main sectors – households which save funds and business firms which invest these funds. A financial market helps to link the savers and the investors by mobilizing funds between them. In doing so it performs what is known as an allocative function. It allocates or directs funds available for investment into their most productive investment opportunity. When the allocative function is performed well, two consequences follow:
• The rate of return offered to households would be higher
• Scarce resources are allocated to those firms which have the highest productivity for the economy.
There are two major alternative mechanisms through which allocation of funds can be done: via banks or via financial markets. Households can deposit their surplus funds with banks, who in turn could lend these funds to business firms. Alternately, households can buy the shares and debentures offered by a business using financial markets. The process by which allocation of funds is done is called financial intermediation. Banks and financial markets are competing intermediaries in the financial system, and give households a choice of where they want to place their savings. …”