Correct Option
The correct option is 2 and 3 only.
Explanation
The circular flow of income in a two-sector economy illustrates the continuous movement of money and goods between Households and Firms. This model typically divides the economy into two distinct markets: the Product Market (where goods and services are sold) and the Factor Market (where factors of production are bought and sold).
Statement-wise Analysis
- Statement 1 is Incorrect: In the standard graphical representation of the circular flow, the upper loop typically represents the Product Market. Here, households purchase goods and services produced by firms, leading to a flow of consumption expenditure from households to firms.
- Statement 2 is Correct: The lower loop conventionally represents the Factor Market (Factors of Production Market). In this loop, households provide land, labor, capital, and enterprise to firms.
- Statement 3 is Correct: In the Factor Market, firms must pay for the factors of production provided by households. These factor payments (rent, wages, interest, and profit) flow from firms to households.
Key Takeaway
Households are the owners of factors of production and consumers of goods; Firms are the producers of goods and employers of factors. Money flows from firms to households as factor income and returns to firms as consumption expenditure.