APPENDIX TO CHAPTER 15

A Four-Sector Circular Flow Model

Sound the trumpets! This exhibit is going to put all the puzzle pieces together. Exhibit A-1 presents
a more complex circular flow model by adding three sectors: financial markets, government, and
foreign markets. In addition to the spending of households for the output of firms shown in the
simplified model in Exhibit 1, these additions add three leakages from the amount of income paid to
households. First, part of households' income is saved. Second, part of it is taxed. Third, part of the
income is spent on imports. On the other hand, this model includes three sources of spending
injections for firms' output other than from households. First, firms purchase new plants, equipment,
and inventories (investment) from other firms. Second, government consumption expenditures are
for goods and services from firms. Third, foreigners purchase exports from the firms.

CONCLUSION The dollar value of all output is sold when the dollar value of leakages
from the income flow (savings, taxes, imports) equals the dollar value of injections of
spending (investment, government, exports).

[Exhibit A-1]

15A-1
Exhibit A-1 The Circular Flow Model of an Open Economy

This exhibit presents a circular flow model for an economy, such as the United States, that engages
in international trade. The theoretical model includes links between the product and factor markets
in the domestic economy and the financial markets, government, and foreign economies. To
simplify the model, only dollar payments are shown for the foreign sector.

15A-2