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Circular Flow Model

The four sector circular flow model includes households, firms, government, and the foreign sector. It revolves around flows of goods, services, and factors of production between these sectors. Households provide labor to firms, government, and the foreign sector, and in return receive income payments. Firms sell goods and services to households, government, and foreign sector to generate revenue. The government collects taxes from households and firms and provides transfer payments and subsidies. The foreign sector exports goods to and imports goods from the other three sectors. Savings from each sector accumulate in the financial sector, which invests money by lending to households, firms, and government.

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610 views2 pages

Circular Flow Model

The four sector circular flow model includes households, firms, government, and the foreign sector. It revolves around flows of goods, services, and factors of production between these sectors. Households provide labor to firms, government, and the foreign sector, and in return receive income payments. Firms sell goods and services to households, government, and foreign sector to generate revenue. The government collects taxes from households and firms and provides transfer payments and subsidies. The foreign sector exports goods to and imports goods from the other three sectors. Savings from each sector accumulate in the financial sector, which invests money by lending to households, firms, and government.

Uploaded by

Ernie Abe
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd

Circular Flow Model

What is the four sector circular flow model? A circular flow of income is a four-sector economy
which includes households, firms, government and foreign sector. The circular flow of income
indicates connections between various areas of our economic system. It revolves around flows
of goods and services and factors of production between firms and households.

Household Sector

Households provides factor services to firms, government and foreign sector. In return, the
households receive factor payments. They also receive transfer payments from the government
and the foreign sector. They also spend their income on payment for goods, services that are
purchased from firms, taxes for government and payments for imports.
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Firms
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Firms receive revenue from households, government and the foreign sector for sale of their
goods and services. Firms also receive subsidies from the government. Firms, like households
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also pay taxes to the government. They also make payments for factor services to households
and imports to the foreign sectors.
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Government
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Government receives revenue from firms, households and the foreign sector for sale of goods
and services, taxes and fees. Government makes factor payments to households and also
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spends money on transfer payments and subsidies.

Foreign Sector

Foreign sector receives revenue from firms, households and government for export of goods
and services. It makes payments for import of goods and services from firms and the
government. It also makes payment for the factor services to the households. The savings of
households, firms and the government sector get accumulated in the financial market. Financial
market invests money by lending out money to households, firms and the government. The
inflows of money in the financial market are equal to outflows of money. It makes the circular
flow of income complete and continuous. Withdrawals There can be withdrawals or leakages
from the circular flow as not all income will flow from households to businesses directly. The

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circular flow shows that some part of household income will be put aside for future spending, for
example, savings (S) in banks accounts and other types of deposit, paid to the government in
taxation (T) e.g. income tax and national insurance and spent on foreign-made goods and
services, i.e. imports (M) which flow into the economy. Withdrawals are increases in savings,
taxes or imports so reducing the circular flow of income and leading to a multiplied contraction
of production (output).

Injections

Injections into the circular flow are additions to investment, government spending or exports so
boosting the circular flow of income leading to a multiplied expansion of output. Three examples
of injections are Capital spending by firms, i.e. investment expenditure (I) e.g. on new
technology, The government, i.e. government expenditure (G) e.g. on the NHS or defense and
Overseas consumers buying UK goods and service, i.e. UK export expenditure (X).
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