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KEYNESIAN AGGREGATE EXPENDITURE MODEL: The generic term for several graphical models used to analysis the basic components of Keynesian economics and to identify Keynesian equilibrium as the intersection of the aggregate expenditures line and the 45-degree line. Differences among the specific models are based on which sectors are included (household, business, government, and foreign) and whether expenditures are induced or autonomous.

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FOUR-SECTOR, THREE-MARKET CIRCULAR FLOW:

A circular flow model of the macroeconomy containing four sectors (business, household, government, and foreign) and three markets (product, factor, and financial) that illustrates the continuous movement of the payments for goods and services between producers and consumers, with particular emphasis on exports and imports. Other circular models are two-sector, two-market circular flow; two-sector, three-market circular flow; and three-sector, three-market circular flow.
The four-sector, three-market circular flow model highlights the key role that the foreign sector plays in the economy. It expands the circular flow model by illustrating how exports add to, and imports subtract from, the domestic flow of production and income. This is the "complete" model containing all four sectors and all three markets.

Four Sectors, Three Markets

The four macroeconomics sectors included in this model are:
  • Household Sector: This includes everyone, all people, seeking to satisfy unlimited wants and needs. This sector is responsible for consumption expenditures. It also owns all productive resources.

  • Business Sector: This includes the institutions (especially proprietorships, partnerships, and corporations) that undertake the task of combining resources to produce goods and services. This sector does the production. It also buys capital goods with investment expenditures.

  • Government sector: This includes the ruling bodies of the federal, state, and local governments. Regulation is the prime function of the government sector, especially passing laws, collecting taxes, and forcing the other sectors to do what they would not do voluntarily. It buys a portion of gross domestic product as government purchases.

  • Foreign sector: This includes everyone and everything (households, businesses, and governments) beyond the boundaries of the domestic economy. It buys exports produced by the domestic economy and produces imports purchased by the domestic economy, which are commonly combined as net exports.
The three macroeconomic markets in this version of the circular flow are:
  • Product markets: This is the combination of all markets in the economy that exchange final goods and services. It is the mechanism that exchanges gross domestic product. The full name is aggregate product markets, which is also shortened to the aggregate market.

  • Resource markets: This is the combination of all markets that exchange the services of the economy's resources, or factors of production--including, labor, capital, land, and entrepreneurship. Another name for this is factor markets.

  • Financial Markets: The commodity exchanged through financial markets is legal claims. Legal claims represent ownership of physical assets (capital and other goods). Because the exchange of legal claims involves the counter flow of income, those seeking to save income buy legal claims and those wanting to borrow income sell legal claims.

Spotlight on the Foreign Sector

The four-sector, three-market circular flow model highlights the role played by the foreign sector. The foreign sector not only buys a portion of gross domestic product flowing through the product markets as exports, it also sells production to the three domestic sectors as imports.

The foreign sector, as such, adds two flows to the model--exports and imports. These two flows are often combined into a single flow--net exports. Unlike other flows, exports and imports can actually change the total volume of the circular flow of production and income.

Exports and Imports

Adding Foreign TradeCircular Flow

This diagram presents the four-sector, three-market circular flow. At the far left is the household sector, which contains people seeking consumption. At the far right is the business sector that does the production. Near the top is the product markets that exchange final goods and services. At the bottom is the resource markets that exchange the services of the scarce resources. Just above the resource markets are the financial markets that divert saving to investment expenditures. In the very center is the government sector. And at the very top, above the product markets is the foreign sector.
  • Exports: With the foreign sector in place, the next step in the construction of the four-sector, three-market circular flow is exports. Exports are goods produced by the domestic economy and purchased by the foreign sector. Exports are represented by a flow from the foreign sector to the core domestic flow. This is the flow of payments into the domestic economy in exchange for the physical flow of goods from the domestic economy. Click the [Exports] button to highlight the flow of exports between the domestic economy and the foreign sector.

  • Imports: Imports are goods produced by the foreign sector that are purchased by the three domestic sectors. Imports are represented by a flow from the core domestic flow to the foreign sector. This is the flow of payments out of the domestic economy in exchange for the physical flow of goods into the domestic economy. Click the [Imports] button to reveal the flow of imports between the domestic economy and the foreign sector.
Combining both flows indicates the key role played by the foreign sector. Imports reduce the total flow of the domestic economy and exports expand the total flow of the domestic economy. Click the [Complete Model] button to illustrate.

What It All Means

What happens when the foreign sector is included in the circular flow model?

  • First, unlike the addition of financial markets and the government sector which merely divert the domestic flow of production and income, the foreign sector can actually change the total volume of the domestic flow. In particular, if exports exceed imports, then the circular flow, in total, is bigger. If the total flow is bigger, then factor payments are bigger, and national income is bigger, and there is more income available for consumption expenditures, saving, taxes, investment expenditures, and government purchases. If imports exceed exports, then the opposite occurs. The total flow is smaller and less income is available for consumption expenditures, saving, taxes, investment expenditures, and government purchases.

  • Second, the impact that exports and imports have on the total volume of the domestic flow indicates why domestic politicians, business leaders, and the general population are perpetually preoccupied with foreign trade, especially promoting exports and restricting imports. The circular flow model indicates that exporting more and importing less does in fact boost the domestic flow, which translates into a higher domestic standard of living.

Other Models

This four-sector, three-market circular flow is one of four alternative circular flow models, each containing a different number of sectors or markets. The other three models are:
  • Two Sectors, Two Markets: The simplest circular flow model contains two sectors (household and business) and two markets (product and resource). This model highlights the core circular flow of production, income, and consumption.

  • Two Sectors, Three Markets: A second version of the circular flow model adds the financial markets to the basic model. This addition illustrates how saving is diverted from the household sector to the business sector to finance investment expenditures.

  • Three Sectors, Three Markets: Another version of the model includes the government sector. This model highlights the importance of taxes, which are also diverted from household sector income and used to finance government purchases.

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Recommended Citation:

FOUR-SECTOR, THREE-MARKET CIRCULAR FLOW, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: January 23, 2018].


Check Out These Related Terms...

     | physical flow | payment flow | circular flow | two-sector, two-market circular flow | two-sector, three-market circular flow | three-sector, three-market circular flow |


Or For A Little Background...

     | exports | imports | net exports | macroeconomic markets | product markets | resource markets | financial markets | macroeconomic sectors | household sector | business sector | government sector | foreign sector | production | consumption | model | market | exchange | economy |


And For Further Study...

     | business cycles | macroeconomic goals | macroeconomic problems | macroeconomic theories |


Related Websites (Will Open in New Window)...

     | World Trade Organization | U.S. International Trade Administration | NAFTA Secretariat |


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