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CSEET · Economic and Business Environment · National Income Accounting and Related Concepts

In a basic two-sector circular flow model (households and firms only, no saving, no government, no foreign trade), what is the relationship between the flow of income received by households and the flow of expenditure on goods and services by households?

Income received by households equals their expenditure on goods and services. In the two-sector model there are no leakages such as saving, taxes or imports, so everything earned is spent and returns to firms, keeping the circular flow constant.

  1. AIncome received equals expenditure on goods and servicesCorrect
  2. BIncome received is always greater than expenditure
  3. CExpenditure is always greater than income received
  4. DThe two flows are unrelated to each other

Explanation

In the simple two-sector model, firms pay households for factor services, and households spend all of that income on firms' output. With no leakages, income equals expenditure, so the flow is continuous and unchanged in size. The options claiming a gap would imply a leakage or injection, which this model excludes.

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