Explain The Circular Flow Of NI In Two Sector Economy In The Presence Of Saving And Investment?

The circular flow of income actually describes the way in which
the income of one person gets transferred to another and in this way a cycle is
maintained. In a two sector model, there is a condition of equilibrium in the economy.
This means that the expenditure that the buyers do is exactly equal to the
income that the seller earns. And then the different firms and business
organizations further use their income to purchase raw materials, pay the labor
etc. In this way, the money again gets transferred to the buyers which are the
common people.

Now we take the case which actually happens that consumers do not spend all of their incomes, rather they also make the savings. The savings lead to create money market in the economy. Through such savings the domestic savings are transferred to producers. In the other words, the firms get the loans from money market and such loans are equal to the savings made by household. Whatsoever people get from financial market in the form of loans is spent on investment expenditures. Such expenditures are made on raw materials and capital goods.

When the people make such expenditures, they become the part of total output of the economy. Thus, the total expenditures consisting of consumption expenditures made by household and investment expenditures made by firms are accorded national expenditures which are the other name of NI at expenditure method. The total summation of consumer goods and capital goods produced by factors of production is known as NI at market prices.

When the factors of production produced the goods or provide services, they get the remunerations in the forms of wages, interest, rent and profits. The summation of such all earnings is also known as NI at factor cost. Thus we find that NI moves from consumers to producers and from producers to consumers in the form of a circular flow.

The two sector economy is one that is controlled by two main variable. Household and firms. GDP = c+I.