The correct option is 2 and 3 only.
Explanation
The circular flow of income is a model that illustrates how money flows through the economy. In its most basic form, known as the "Simple Economy" or Two-Sector Model, the economy is viewed as a closed loop consisting solely of two agents: households and firms.
Statement-wise Analysis:
- Statement 1 is Incorrect. A "simple economy" model assumes a closed economy with no government intervention and no external trade sector (exports and imports). It consists strictly of two sectors: households (owners of factors of production) and firms (producers of goods and services). The introduction of government and external trade characterizes a three-sector or four-sector open economy model.
- Statement 2 is Correct. In this simplified model, firms distribute their entire revenue as factor payments (wages, rent, interest, profit) to households. Conversely, households spend their entire income on the consumption of goods and services produced by firms. Therefore, aggregate consumption by households is identical to the aggregate expenditure on goods produced by firms.
- Statement 3 is Correct. The simple two-sector model operates on the assumption that households do not save; they spend their entire income on consumption. Consequently, there are no leakages (such as savings, taxes, or imports) from the circular flow, and the flow of income remains constant in volume.
Key Takeaway:
The circular flow of income in a simple economy assumes a two-sector system (Households and Firms) where Production = Income = Expenditure. It assumes no government, no external trade, and no savings (leakages).