Households and Firms depend on each other in the circular flow of income: Justify the statement in case of a two-sector model.

The above statement is justified in a two-sector economy.

In a two-sector economy, there are only two sectors.

1. Firm
2. Households

the following statement is justified under the following assumption.

1. Households spend all their income
2. Firms retain nothing as undistributed profit
3. Savings are nil for both households and firms

Now, Let’s understand how it happens

The firm solely depends on households for factor services.

The households provide factor services (land, labour, capital, and entrepreneurship) to the firms.

In return, firms make payments to the factor of production in the form of rent, wages, interest, and profit) to households.

Households spend the entire factor income received on the purchase of goods and services produced by firms.

Households solely depend on the firm for the goods and services to satisfy their wants.

The Same Money is used by the firm to pay for factor services of households in the Second round of production.

Thus firms and households depend on each other in a two-sector economy to make the flow of income circular.