Circular Flow Of Income Two Sector Model Santosh

Circular Flow Of Income Two Sector Model Santosh Borkakati Asst. Professor Department of Economics Mangaldai College

Two Sector Model Economy divided into two sectors Economy Production or Business Sector Household or Consumption Sector

Production Sector • Production sector produces goods and services. • The process of production is a continuous process. Factors of production such as land , labor, capital & entrepreneurship are combined together for the production of goods & services. • Production sector supplies goods and services to household sector.

Household Sector • The supply of factors of production come from households. These factors offers their services to the producers who in returns produce goods &services & make payments as reward in the form of rent, wages, interest & profits. • The households spend this money on goods & services produced by producers. Thus income or money first flows production to the households in the form of factor payments & then from the households to the production in the form of consumption expenditure. • The income continue to flow in a circular way so it is called circular flow of income.

Two Sector Model Factor Services Payment for Factors Producers Households Payment For Goods & Services Goods and Services

Two Sector Model With Savings Factor Services Factor Payments Borrowing Producers Saving Capital Market Saving Households Borrowing Payments for Goods and Services Goods & Services

• In the previous model , it is assumed that household sector and firms do not save at all. But in actual practice it does not happen so. Households save some part of their income for various reasons like precautionary reasons, transactionary reasons &speculative reasons. § Similarly firms also save some of their receipts for reasons like -expansion of their business etc. • All the banking institutions, insurance companies & financial houses taken together constitute capital market of the economy. • From capital market these savings flow to firms as loans for investment.

Withdrawals & Injections • In reality, however, there are leakages from and additions to the circular flows of income and expenditure • The leakages and additions are also called withdrawals and injections, respectively. 8

Withdrawals § Withdrawal is the amount that is set aside by the households and the firms and is not spent on the domestically produced goods and services over the period of time. Example a household sets aside a part of income for old age or against the loss of job. § Saving is a withdrawal. § When savings are invested, they take a form of injections § Firms may also withhold a part of their total receipts and may not return it to the circular flows in the form of factor payments in anticipation of depression § Such withdrawals reduce the size of circular flows 9

Injections • Amount that is spent by households and firms in addition to their incomes generated within the regular economy • Injection by the household may be in the form of spending inherited savings or the hoarding • Firms can inject money by spending their retained earnings or borrowing from outside • Injections increase the size of circular flows 10

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