Q.In a two-sector economy, the Aggregate Demand can be determined by adding __________ and __________. (Choose the correct option to fill in the blanks) (A) consumption, investments (B) investments, savings (C) consumption, savings (D) savings, exports

In a two-sector economy, only households and firms exist—there is no government and no foreign trade. Households consume and save, while firms invest.

Aggregate Demand represents the total planned expenditure on final goods and services in the economy. It comprises all spending components that create demand for output. In this simplified two-sector model, the only two sources of expenditure are:

1. Consumption expenditure ($C$) by households on goods and services
2. Investment expenditure ($I$) by firms on capital goods

Thus, $AD = C + I$. …

The structure of a two-sector economy

A two-sector economy is the simplest macroeconomic model: it contains only households and firms, with no government and no foreign trade. Households supply factors of production (labor, capital, land) to firms and receive income in return. They then decide how to allocate that income between consumption and saving. Firms produce goods and services, paying out income to households and undertaking investment in capital goods.

The circular flow in this model has two key spending streams. Households spend on consumption goods — food, clothing, services, durables — which constitutes consumption expenditure ($C$). Firms spend on capital goods — machinery, buildings, inventories — which constitutes investment expenditure ($I$). These are the only two categories of final expenditure in a two-sector world.

What Aggregate Demand means

Aggregate Demand is the total planned expenditure on domestically produced final goods and services at a given income level. It answers the question: how much do all agents in the economy want to buy at current prices and income?

In the two-sector model, only households and firms are doing the buying. Households buy consumption goods, firms buy investment goods. There is no government purchasing goods and services (no $G$), and no foreign buyers purchasing exports (no $X$). So the components of Aggregate Demand collapse to just two:

This is the fundamental identity for Aggregate Demand in a two-sector economy.

Why not savings?

A common confusion: since households split their income between consumption and saving ($Y = C + S$), why isn't saving a component of Aggregate Demand? …