Section 4: The Circular Flow (2024)

FAQs

What is the 4 sector circular flow model? ›

The four-sector circular flow model consists of individuals, businesses, the government, and overseas. The financial sector is not included. The overseas sector is made up of imported (M) and exported (X) commodities and services, also known as foreign commerce.

The four main parts of the circular flow diagram are individuals, firms, market for goods and services, and market for factors of production. These four parts serve as a framework for understanding the continuous flow of money throughout an economy.

So a typical economy consists of four main groups: households, businesses, governments, and foreign markets.

The circular flow of income or circular flow is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. between economic agents. The flows of money and goods exchanged in a closed circuit correspond in value, but run in the opposite direction.

The 4 different sectors of the economy are primary sector, secondary sector, tertiary sector and quaternary sector. The quaternary sector of the economy is based upon the economic activity that is associated with either the intellectual or knowledge-based economy.

These markets include: factor market, • product market, • financial market, and • foreign exchange market. These are markets where factors of production are traded. These include all markets where labour, resource and capital are bought and sold.

Each has its own distinguishing characteristics, although they all share some basic features. Each economy functions based on a unique set of conditions and assumptions. Economic systems can be categorized into four main types: traditional economies, command economies, mixed economies, and market economies.

The flow of money, resources and services, which characterises the economic cycle, facilitates demand and supply. The role-players in the economy include households, business, government and the foreign sector. These participants are involved in the processes of production, consumption and exchange.

The 4 main types of economic systems are traditional economies, command economies, market economies, and mixed economies. Traditional economies are based on conventional forms of providing sustenance. In command economies, rulers hold the power over production and distribution.

In the basic (two-factor) circular flow model, money flows from households to businesses as consumer expenditures in exchange for goods and services produced by the businesses, then flows back from businesses to households for the labor that individuals provide.

Who are the participants in the circular flow? ›

The circular flow model shows the interaction between two groups of economic decision-makers—households and businesses—and two types of economic markets—the market for resources and the market for goods and services.

The circular flow model demonstrates how money moves through society. Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money. That is the basic form of the model, but actual money flows are more complicated.

The model described above is the two-sector model, which is the most basic model containing only two sectors: individuals or households and businesses. In the two-sector model, it is assumed that households spend all their incomes as consumer expenditures and purchase the goods and services produced by businesses.

In the four-sector model, leakages include savings (S), taxes (T), and imports (M). Injections include investment (I), government spending (G), and exports (X). The equilibrium level of income and output is achieved when total leakages equal total injections.

The circular flow model highlights the “flows” within the economy—the flow of economic resources, goods and services, and the flow of money.

Example of Circular Flow Diagram

Imagine that the dollar begins at a household, sitting in, say, your wallet. If you want to buy a cup of coffee, you take the dollar to one of the economy's markets for goods and services, such as your local Starbucks coffee shop. There you spend it on your favorite drink.