The economy that consists of only two sectors i.e. household sector and business sector is called two-sector economy. This is the most simple economic model which is regarded as the unrealistic economic model because it ignores the government and foreign sector. Such kind of economy is not practical in today's world. This economic model is often regarded as a closed economy.
Assumptions:
- There is only Household & Business sector in this economy.
- All income is spent on consumption which means no savings.
- There is no government & international trade.
- Factors of production are supplied by household sectors.
- Business sector hires the factors of production.
- Business sector produces goods and services which are consumed by the household sector.
The flow of income and expenditure in a two-sector economy is explained with the help of the figure below:
In the figure above, circular flow of income and expenditure in a two-sector economy is shown. Household sector supplies the factors of production like land, labor, capital, and organization, etc. to the business sector. And the business sector provides factors of payment like rent, wages, salaries, interest, and profit, etc in return of those factors of production. In this economic model, there is both real flow money flow. The flow of real flow leads money flow and vice versa. There is money flow in term of rent, wages, salaries, interest, and profit, etc. in return to real flow i.e. factors of production. From the figure above, it is clear that factor services and money flow in the opposite direction.
