In a two sector economy, the flow of factor payments moves from to . (Choose the correct option to fill in the blanks)
In a two sector economy, the flow of factor payments moves from to . (Choose the correct option to fill in the blanks)
Options
Official answer
Correct option: (A) firms, households.
In a two-sector economy (only households and firms), factor payments always flow from firms to households, because households own and supply the factors of production that firms use.
Marking scheme
- 1.1 mark for selecting option (A) firms, households — objective type question, no partial credit.
Hint
Factor payments compensate households for supplying factors of production to firms — think of who pays whom for using land, labour, capital.
Quick oral answer
Factor payments flow from firms to households because households supply the factors of production and firms pay them for using these factors.
Common mistakes
- 1.Confusing the factor payment flow (firms to households) with the flow of goods and services, which moves in the opposite direction (firms to households as well, but paid for by households to firms).
- 2.Assuming government or banks are part of the flow in a strictly two-sector model, when only households and firms exist.
Analysis and explanation
This tests the direction of the money flow of factor payments in the basic circular flow model.
Why (A) is correct
- Households supply land, labour, capital and entrepreneurship to firms.
- In return, firms make factor payments — rent, wages, interest and profit — to households.
- This money flow is opposite in direction to the real flow of factor services (households to firms) and to the flow of goods/services (firms to households).
Why the others are wrong
- (B) firms, government — a two-sector model has no government sector at all.
- (C) banks, households — banks are financial intermediaries, not one of the two sectors (households/firms) in this model.
- (D) households, firms — this reverses the direction; households pay firms for goods/services, not factor payments.
Interesting facts
The two-sector circular flow model assumes no savings, taxes, or foreign trade — in reality, modern economies are four-sector models (households, firms, government, rest of the world).
In the two-sector model, total factor income received by households always equals total expenditure by firms on factors, keeping the flow in perpetual balance (Y = C = E).
Question details
Q1 of 37 questions
- Board
- CBSE
- Class
- Class 12
- Subject
- Economics
- Year
- 2026
- Section
- Section A
- Marks
- 1
- Type
- MCQ
- Chapter
- National Income and Related Aggregates
- Topic
- Circular Flow of Income
- Bloom's level
- remember
- Syllabus topic
- Unit 2: National Income and Related Aggregates — Circular Flow of Income in a Two Sector Economy
- Author
- CBSE
- Reviewed by
- Padhantu Academic Team
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Frequently asked questions
Why do factor payments flow from firms to households and not the reverse?
Because households own the factors of production (land, labour, capital, entrepreneurship) and supply them to firms. Firms use these factors to produce goods and services, and in exchange pay rent, wages, interest and profit to households — this payment flow is called the factor payment (or income) flow.
What is the difference between the real flow and the money flow in the circular flow model?
The real flow refers to the physical movement of factor services (households to firms) and goods/services (firms to households). The money flow refers to the payments made in the opposite direction of each real flow: firms pay factor incomes to households, and households pay for goods and services to firms.