Elaborate the two components of Aggregate Supply in a two-sector economy.

Question

Accepted Answer

In a two-sector economy, Aggregate Supply (AS) has two components:

**1. Consumption Expenditure (C):** This is the total expenditure by households on goods and services. Consumption is a function of income: C = C̄ + bY, where C̄ is autonomous consumption (consumption at zero income) and b is MPC (marginal propensity to consume).

**2. Saving (S):** This is the part of income that is not consumed. Saving is also a function of income: S = -C̄ + (1-b)Y, where -C̄ is dissaving at zero income and (1-b) is MPS (marginal propensity to save).

**Key Relationship:** Y = AS = C + S
National income (Y) is either consumed or saved. The 45° line represents AS because at every point on this line, Y = C + S.