Write a note on the circular flow of income in a two-sector economy?

CIRCULAR FLOW OF INCOME IN A TWO-SECTOR ECONOMY:
*INTRODUCTION:
~ The two sector model is highly simplified models with only two sector-i.e. households and firms.
~ It illustrates the circular flow of income between these two sectors.
*ASSUMPTIONS:
i) There are no saving by households or firms.
ii) There is a certain degree of monetization in the economy.
iii) The level of inventories held by the firm remains constant.
iv) Firms do not retain anything as undistributed profits.
v) There is no economic activity by the government i.e the government dose not receive any money by way of taxes nor does it spend money on goods and services.
vi) There is absence of international trade i.e there are no imports and exports. It is a closed economy.
*ILLUSTRATION:

*EXPLANATION:
~ The above illustration depicts the circular flow of income in a two-sectored economy.
~ These two sectors comprise: households and firms.
~ The inner circular flow represents the REAL FLOW of income whereby the households supply the factors of production to the firms in the form of land, labour, Capital and Enterprise.
~ The firms, in return, provide the households with goods and services that are produced by using the above factors of production.
~ The outer circular flow of income represents the MONEY FLOW of income.
~ The money flows from the firm to the households in the form of rent, wages, interest and profits. It is a reward/income for supplying the factors of production to the firms.
~ Similarly money flows from the households to the firms in the form of purchase of goods and services for satisfaction of wants. This is the consumption expenditure of the households that becomes the income of the firms.
~ Thus, there is a circular flow of income wherein income flows from firms to households in the form of factor payments and from households to firm as consumption expenditure.
~ This circular flow of income is a continuous process though it will not always remain at a constant level.
~ During depression, there will be a smaller flow of money, while in prosperity, it will be in larger volume.
~ This indicates that changes in national income (during prosperity/depression) affect the circular flow of income in an economy.
*CONCLUSION:
~ This is an unrealistic representation of the overall economic activity because it disregards savings and investment expenditures.
~ It also disregards the government sector, which constitutes a larger share in the income flow.

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