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Managerial Economics

Notes Figure 14.3: The Circular Flow of Income in a Three-sector Economy

14.5.3 Circular Flow of Income in a 4 Sector Model

In a 4 sector model, an economy moves from being a closed economy to an open economy. In an
open economy imports and exports are made. You must understand that one country’s exports
are other country’s imports. In case of a country imports, money flows to the rest of the world
and in case of exports, money flows in from the rest of the world. An economy experiences a
trade surplus if its exports exceed its imports. On the other hand, there is a trade deficit if imports
exceed exports. Imports act as leakages and exports as injection into the circular flow of income
in an economy.

In a 4 sector model, we have,
Y = C + I + G + (X-M)
Where,
Y = Income or Output
C = Household consumption expenditure

I = Investment expenditure
G = Government expenditure
X – M = Exports minus Imports

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