In a two-sector economy, income is a function of

Analyze the question: A two-sector economy has only two participants: households and firms. There is no government (so no taxes or government spending) and no foreign trade (so no exports or imports).

Concept: In national income analysis, income (Y) can be measured from the expenditure side:

• Y = C + I + G + (X − M) for a full (four-sector) economy.
• Remove G (government) and X − M (foreign sector), and you are left with the two-sector formula:

Y = C + I

where C is consumption by households and I is investment by firms.

Check each option:

• A. C + I: matches the two-sector formula. ✔
• B. C + I + tax: taxes involve the government, which makes it a three-sector economy. ✘
• C. C + I + expenditure: "expenditure" is vague. Consumption and investment are already expenditures, and government expenditure is not part of a two-sector economy. ✘
• D. C + exports + imports: this involves the foreign sector and is wrongly structured, since imports are subtracted. ✘
• E. Saving + investment: this is not the income identity. Saving equals investment only at equilibrium (S = I), and income from the income side is Y = C + S. ✘

Answer: Option A.

Tip: Count the sectors:

• 2 sectors: Y = C + I
• 3 sectors: Y = C + I + G
• 4 sectors: Y = C + I + G + (X − M)

Also remember that on the income side, Y = C + S. At equilibrium, C + S = C + I, so S = I.