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CA Foundation · Business Economics · Determination of National Income

In the circular flow of income in a simple two-sector economy (households and firms) with no saving, which of the following correctly describes the flows?

Households supply factors of production to firms and receive factor incomes, while firms supply goods and services and receive consumption expenditure. This creates the real and money flows in opposite directions. The other options reverse the roles of households and firms or introduce government taxes and subsidies.

  1. AHouseholds supply factors of production to firms and receive factor incomes; firms supply goods and services and receive consumption expenditureCorrect
  2. BHouseholds supply goods and services to firms and receive profits
  3. CFirms supply factors of production to households and receive wages
  4. DHouseholds pay taxes to firms and receive subsidies in return

Explanation

In the two-sector model, the real flow runs from households to firms as factor services and from firms to households as goods and services. The money flow runs the opposite way: factor payments to households and consumption expenditure to firms. The other options reverse the roles or bring in government flows that do not exist in this model.

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