State and discuss any one component of Aggregate Demand in a two-sector economy.

Question

Accepted Answer

In a two-sector economy, Aggregate Demand (AD) has two components:

**1. Private Consumption Expenditure (C):** This is the total expenditure by households on purchasing goods and services during an accounting year. Consumption expenditure is influenced by the level of disposable income. Higher disposable income leads to more consumption expenditure. The consumption function is expressed as: C = C̄ + bY, where C̄ is autonomous consumption and b is MPC.

**2. Investment Expenditure (I):** This is the total expenditure incurred by all private firms on capital goods. It includes additions to the stock of physical capital assets like machinery, equipment, buildings. In the two-sector model, investment expenditure is assumed to be autonomous, meaning it is independent of the level of income.