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Four sector diagrams of circular flow open economic system

Fig 1.1 four sector circular flow in open economic system

Mekdela Amba University
Department of economics
Course title :- introduction to economics
Course code econ-1011
Economics Individual Assignment
submitted Instructor ----------------kasahun G
sub mission Date ------------------ 26/09/2016 E.C
Name henok kassie
section “H’’ ID No 1600681
 1. Draw the diagrams & explain four sector of circular flow in open economic system.

Answer
In an open economy, decision-making units interact through various channels such as trade, capital flows, and
foreign exchange markets. The decision-making units in an open economy include households, government,
firms and the foreign sector.

1. Households: In an open economy, households make decisions regarding consumption, saving, and
investment. They interact with the foreign sector through trade, where they can purchase imported goods and
services or sell domestically produced goods and services to other countries. Households also participate in the
foreign exchange market when they exchange their currency for foreign currency for international transactions.

2 Firms:

The firms receive revenue for the sale of goods and services from the government, households, and
foreign sectors. They also receive subsidies from the government to produce goods and services.
Besides, the firms make payments for taxes to the government, factor services to the households, and
imports to the foreign sector.

3 Government:

The government plays a significant role in an open economy by making decisions on fiscal policy
(taxation and government spending) and monetary policy (interest rates and money supply). The
government interacts with the foreign sector through trade agreements, foreign aid, and participation
in international organizations.

4 Foreign Sector:

The foreign sector includes other countries, international organizations, and foreign investors. It
interacts with the domestic decision-making units through trade, investment, and financial
transactions. Foreign countries can influence the domestic economy through trade policies, exchange
rate movements, and capital flows.

Overall, decision-making units in an open economy interact through various channels to facilitate international
trade, investment, and financial transactions. These interactions can impact economic growth, employment,
inflation, and overall economic stability in both domestic and foreign economies.

Prepared by henok kassie

 Circular Flow in a Four-sector Economy
Besides households, firms, and the government, the foreign sector also plays a crucial role in an
economy. Therefore, the circular flow in a four-sector economy consists of households, firms,
government, and the foreign sector. Money flows in each of these sectors are as follows:

1. Household Sector:

The household sector of an economy provides factor services to the firms, government, and the
foreign sector for which it received factor payments in return. Besides factor payments, the
households also receive transfer payments like old age pensions, scholarships, etc., from the
government and foreign sector. The household sector spends its earned income on Payments for
goods and services purchased from firms, payments for imports, and tax payments to the
government.

2. Firms:

The firms receive revenue for the sale of goods and services from the government, households, and
foreign sectors. They also receive subsidies from the government to produce goods and services.
Besides, the firms make payments for taxes to the government, factor services to the households, and
imports to the foreign sector.

3. Government:

The government receives revenue for the sale of goods and services, fees, taxes, etc., from the firms,
households, and the foreign sector. It also makes factor payments to households and spends its
revenue on transfer payments and subsidies.

4. Foreign Sector:

The foreign sector receives revenue for the export of goods and services from firms, households, and
the government. It also makes payments to firms and the government for the import of goods and
services, and households for the factor services.

The financial market also plays an important role in a four-sector economy as the savings made by the
households, firms, and the government gets accumulated here and this money is invested by the
financial market in the form of loans to firms, households, and the government. The inflows of money
in the financial market in a four-sector economy are equal to the outflows of money, which makes the
circular flow of income continuous and complete.