Understanding Circular Flow in a Two-Sector Economy with Financial Market

In a two-sector economy with a financial market, households and firms engage in savings, investments, and borrowing through the financial market, unlike the simple circular flow assumption where no savings are made. This interaction between households, firms, and the financial market plays a crucial role in the economy's overall functioning and growth.

• Circular flow
• Two-sector economy
• Financial market
• Savings
• Investments

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1. CIRCULAR FLOW IN A TWO- SECTOR ECONOMY (WITH FINANCIAL MARKET)

2. Circular Economy (with Financial Market) Flow in a Two-sector In the circular flow of an economy in a two-sector model without the financial market, it is assumed that no savings are made in the economy. It means that the households spend their entire income on the purchase of goods and services and every firm spends all the receipts from the sale of goods and services to make factor payments.

3. Circular Flow in a Two-sector Economy (with Financial Market) However, it does not happen in the actual world, i.e., households do not spend their entire income on the consumption of goods and services. Instead, they save a part of their income for the future. In the same way, the firms save some part of their receipts for the expansion of business or various other reasons. Besides, the firms also borrow money from outside to finance their expansion plans. All of these savings and borrowings happening in the economy are channelised through the financial market. Therefore, in a two-sector economy, the savings made by households accumulated in the financial market are used by the firms for investment purposes.

4. This understood following diagram: concept can the be better of with help the