Question

"Households and firms depend on each other in the circular flow of income." Justify the statement in case of a two-sector model.

Answer 1

Households and firms depend on each other in the circular flow of income in case of a two-sector model. Participants of the two-sector economy are households and producers. Flow of money from producers to households as payments for the purchase of factor services has been a continuous process. So, there has been the flow of money from households to producers as payments for the purchase of consumer goods and services, This non-stop continuity of inter-sectoral flows is called 'circularity of flows'. Hence, total consumption by households is always equal to total production by the producers.