Identify the correct statement with regards two sector economy model:
A. Total factor income is equal to aggregate consumption expenditure.
B. Consumers can dispose off their earnings through spending their entire income on consumption.
C. Balance of trade surplus.
D. Fair society through progressive tax regime.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → A and B only
Picture an economy with only households and firms: no government, no foreign trade and no saving. Firms pay households factor incomes for their services, and households spend all of this income on what the firms produce, so the money flows back to the firms. This is the two-sector model of the circular flow; A and B describe it, while C and D need sectors it does not have.
A. Total factor income is equal to aggregate consumption expenditure. True. Firms pay wages, rent, interest and profit to households for their services. Since households spend the whole of this income on the firms’ output, aggregate consumption expenditure equals total factor income, and the income comes back to the firms as sales revenue.
B. Consumers can dispose off their earnings through spending their entire income on consumption. True. This is the one way households can use their income in this model, because the other channels are closed: they do not save, there is no government to pay taxes to, and there are no imports to buy.
C. Balance of trade surplus. False. The balance of trade is the value of exports of goods minus the value of imports of goods, so it needs dealings with other countries. The two-sector model has no foreign sector, so there are no exports or imports and no balance of trade at all.
D. Fair society through progressive tax regime. False. A progressive tax takes a larger share of a larger income, and the government uses it to make the distribution of income fairer. There is no government in the two-sector model, so there are no taxes, progressive or otherwise.
NCERT (2025-26): “2.2 Circular Flow of Income and Methods of Calculating National Income … In this simplified economy, there is only one way in which the households may dispose off their earnings – by spending their entire income on the goods and services produced by the domestic firms. The other channels of disposing their income are closed: we have assumed that the households do not save, they do not pay taxes to the government – since there is no government, and neither do they buy imported goods since there is no external trade in this simple economy. In other words, factors of production use their remunerations to buy the goods and services which they assisted in producing. The aggregate consumption by the households of the economy is equal to the aggregate expenditure on goods and services produced by the firms in the economy.…” |