Read the following statements - Assertion (A) and Reason (R):
Assertion (A): In the circular flow of income in a simple economy, the amount that the firms distribute as factor payments equals the aggregate consumption expenditure that they receive as sales revenue.
Reason (R): The simple economy functions without a government, external trade or any savings.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
Assertion (A): In the circular flow of income in a simple economy, the amount that the firms distribute as factor payments equals the aggregate consumption expenditure that they receive as sales revenue. — True. In the simple economy there is no leakage: factor payments and sales revenue are equal.
Reason (R): The simple economy functions without a government, external trade or any savings. — True. The simple economy is assumed to have no government, no external trade and no savings.
Why R explains A?
Without savings, taxes or imports, households have no other use for their income. They spend all of it on firms’ goods, so sales revenue equals factor payments.
NCERT (2026-27): “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. The entire income of the economy, therefore, comes back to the producers in the form of sales revenue. There is no leakage from the system – there is no difference between the amount that the firms had distributed in the form of factor payments (which is the sum total of remunerations earned by the four factors of production) and the aggregate consumption expenditure that they receive as sales revenue. …” |