(i) Explain the concept of circular flow of income in a two-sector economy. (ii) "Gross Domestic Product (GDP) and sum of Gross Value Added (GVA) in an economy are always equal." Justify the given statement with valid arguments. (i) "Gross Domestic Product (GDP) Deflator is represented by the ratio of Real GDP and Nominal GDP." Do you agree with the given statement ? Justify your answer with valid arguments and a hypothetical numerical example. (ii) State the meaning of income from Property and Entrepreneurship.

Question

Accepted Answer

(i) In a **two-sector economy** with only households and firms, the circular flow works as follows:
- Households provide factor services (land, labour, capital, enterprise) to firms
- Firms produce goods and services using these factors
- Firms make factor payments (rent, wages, interest, profit) to households
- Households spend this income on consumption of goods and services from firms

This creates a continuous loop where income flows from firms to households and back to firms through consumption expenditure.

(ii) **GDP = Sum of GVA** is always true because:
- GDP measures the final value of goods and services produced
- GVA measures the value added at each stage of production
- The sum of all value added equals the final value of output
- Mathematically: GDP = Σ(GVA) + Product taxes – Product subsidies
- When product taxes equal subsidies, GDP = Σ(GVA)