Two sector of circular flow
The circular flow of income and expenditure refers to the process where by the national income and expenditure of an economy flow in a circular manner continuously through time. The components of national income and expenditure such as saving, investment, taxation, government expenditure, exports, imports, etc. are on diagrams in the form of currents and cross-currents in such a manner that national income equals national expenditure.
Circular Flow in a Two Sector Economy
We begin with a simple hypothetical economy where there are only two sectors, the household and business. The household sector owns all the factors of production, that is land, labour and capital. This sector receives income by selling the services of these factors to the business sector.
The business sector consists of producers who produce products and sell them to the household sector or consumers. Thus the household sector buys the output of products of the business sector. The circular flow of income and expenditure in such an economy is shown in Figure I where the product market is shown in the upper portion and the factory market in the lower portion.
In the product market, the household sector purchase goods and services from the business sector while in the factor market the household sector receives income from the former for providing services. Thus the household sector purchases, all goods and services provided by the business sector and makes payments to the latter in lieu of these.
The business sector, in turn, makes payments to the households for the services rendered by the latter to the business-wage payments for labour services, profit for capital supplied, etc. Thus payments go around in a circular manner from the business sector to the household sector and from the household sector to the business sector, as shown by arrows in the output portion of the figure.
There are also flow of goods and services in the opposite direction to the money payments flows. Goods flow from the business sector to the household sector in the product market and services flow from the household sector to the business sector in the factor market, as shown in the inner portion of the figure. These two flows give GNP-GNI.
