Circular Flow in the Four Sector Economy

 This model is the final and the realistic model

 Formed by adding the foreign sector to the three sector model
 The foreign sector consists of two types of international transactions:
o Foreign trade i.e. export and import of goods and services
o Inflow and outflow of capital

For simplicity we make the following assumptions:

 The external sector consists of only export and import of goods and services
 The export and import of goods and non-labor services are done by the business firms
 The household sector export only labor
 There is minimum government intervention
 There exists perfect competition in both domestic and foreign markets

The four sector model can be explained with the help of following figure
 Like previous this figure shows only the money flows, each money flow has a
counterpart goods flow in opposite direction
 The lower part of the figure shows circular flows of money in respect of foreign trade.
 Exports(X) make goods and services flow out of the country and make money (foreign
exchange) flow into the country in terms of “receipts from exports”.
 Exports (X) represent injection in to the economy
 Imports (M)make inflow of goods in the country and flow of money (foreign Exchange)
out of county
 Import (M) represent withdrawal from the circular flow of income.
 Another income flow is generated by the the export of manpower by the household; and
bring remittances in terms of foreign exchange
 These inflow and outflow go on continuously so long as there is foreign trade and export
of manpower

The total circular flow in the economy is depends on the foreign trade
balance which equals X-M
 X represent injections and M represents withdrawals.
  X>M inflow of foreign income is greater then outflow; this represent injections in the
economy
 The net gain increases the magnitude of circular flow in the economy
 X<M there is net withdrawal from the economy and it decreases the magnitude of
circular flows.
 If X=M inflow and outflow is equal leaves the circular flow unaffected.

To measure the National income imports must be subtracted from the total expenditure made
by foreigners on our domestically produced goods and services exported to them to get the
value of net exports.

Thus in open economy

Y = C+ I + G + (X – M)