IN THE FOUR SECTOR ECONOMY
The four sector economy consists of the household sector, business sector or firms, government sector, and foreign sector or rest of the world. It is also known as the open economy. This model is formed by adding the foreign sector to the three-sector model. The model studies all sectors of the economy dropping all simplifying assumptions made for the two and three-sector models.
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Assumptions
The circular flow of income and expenditure in the four sector economy is based on the following assumptions:
- There are four sectors in the economy which include household, business, government, and foreign sectors.
- There is no restriction on import and export.
- There is minimal government intervention.
- There is perfect competition in both internal and external markets.
- There is a well-managed financial market.
- Households export only labor and capital.
- Business firms export and import only goods and services.
On the basis of these assumptions, we can illustrate the circular flow of income and expenditure in the following diagram.
In the figure, the lower half of the circular flow shows circular flows of money in respect of foreign trade. Exports, as an injection to the economy, make goods and services flow out of the country and make money flow into the country in the form of export earnings. Similarly, imports as the withdrawals from the circular flows, make the flow of goods and services in and flow of foreign exchange out of the country. Another flow is generated by the export of factor services, (especially, labor and capital) by the households. The exports of these services bring in factor payments as a form of foreign remittances in terms of foreign exchange. These flows and outflows go on continuously so long as there is foreign trade and export of factor services.
