FOUR SECTOR MODEL OF

NATIONAL INCOME
─

BY
DIVYADARSHINI G
MADUMITA R
RAHINI S
RAKSHA J
RAKSHITAA C
ROHINI V
SHAMILI A
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Introduction
The Keynesian four sector model depicts the overall macroeconomic
including the interaction between domestic and foreign markets. Due to the
presence of foreign sector, the determination of income/output equilibrium
under four sectors is influenced by net exports as well. These sectors are
● households
● businesses
● the government and
● the foreign sector (or the rest of the world).
The foreign sector primarily means the export and import of goods and
services. Therefore, this Four Sector Model is also called an Open Economy
Model. In the Four Sector Model, imports are treated as expenditure and
become a leakage. Whereas exports boost the national income.

Assumptions of the Four Sector Model

This model drops the unrealistic assumptions of the two- and three-
sector models. Following are the assumptions of a four-sector model:
● The entry and recognition of the Foreign Sector in this
model leads to no restrictions on the import and export in
general. Specific restrictions like the trading country,
product, etc may be there.
● The Government intervention is minimal.
● Both domestic and foreign markets feature perfect
competition.
● Household exports labor and capital, while businesses
export goods and services.
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Diagram depicting four sector model

Understanding Four Sector Model

Household Sector
The Household Segment plays a critical role in the Economic
Development of any Country. This sector acts as:

1. A producer
2. Works as a factor of production
3. Transfer payments
4. Acts as a consumer
5. Pays taxes to the Government
6. Act as Saver
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Business Sector
Businesses get revenue from selling goods and services to households,
as well as through exports. They also get subsidies from the
government.

On the other hand, payments from businesses to other sectors include

factor payments, taxes, import payments, and more.

Government Sector
The segment includes two types of activities. The First one is
governance, welfare activities, services, and so on. The second
segment is where the government owns and operates certain
businesses.

The primary income source for the government is tax collections from
households and businesses. Also, the government gets interests and
dividends from investing in businesses, as well as international grants
and loans.

On the other hand, payment from the government includes transfer

payments, subsidies, grants, and more. The transfer payments involve
sending money to households through pension funds, scholarships,
and more. Also, the government buys goods and services from
businesses.

Foreign Sector
This sector gets income from businesses, governments, and
households who import goods and services from other countries.

On the other hand, the foreign sector makes payments to businesses

and governments when they export goods and services to other
countries. It also makes factor payments to households.

In the case of exports being more than imports, there is a surplus

balance of payment. And, when the imports exceed exports, there is a
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deficit balance of payment in the economy. The government uses

different policies to maintain a balance between imports and exports.

Determination of Equilibrium
Output/Income
We can use the four-sector model to determine the equilibrium
income/output in an economy. Using the aggregate expenditure
method, we can get the equilibrium income/output by adding the
expenditure from all four sectors.

So, equilibrium income/output = C + I + G + (X – M)

Here ”C” is the household expenditure, ”I” is a business expenditure,

”G” is government purchase, while ”X – M” is the net foreign demand
or ”Exports less Imports.”
If other things remain the same, the income and output in an economy
will go up with a rise in exports and a drop in imports. And, the income
and output level in an economy will drop if there is a jump in imports
and a drop in exports.

From the above graph:

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● Equilibrium is identified as the intersection between the C + I +

G + (X - M) line and the 45-degree line. The equilibrium income
is Y.
● From panel B, it is clear that the leakages(S+T+M) are equal to
injections (I+G+X) only at equilibrium level of income.
● If net exports are positive (X > M), there is net injection and
national income increases. Conversely, if X<M, there is net
withdrawal and national income decreases.
● The graph depicts a case of X<M.
● If M>X, the aggregate demand schedule C+I+G shifts downward
with equilibrium point shifting from F to E and causes a reduction
in national income from Y0 to Y1.
● If X > M, the aggregate demand schedule C+I+G shifts upward
causing an increase in national income.

Final Words
An increase in the demand for a country’s export has an expansionary
effect on equilibrium income, whereas an autonomous increase in
imports has a contractionary effect on equilibrium income. However ,
this should not be interpreted to mean that exports are good and
imports are harmful in their economic effects. Countries import goods
that can be more efficiently produced abroad and trade increases the
overall efficiency of the worldwide allocation of resources. This forms
the rationale for attempts to stimulate the domestic economy by
promoting exports and restricting imports.

The four-sector model is closer to reality than the two-sector and

three-sector because of the introduction of the foreign sector. The
Addition of the foreign sector transforms the model from a closed to an
open economy.