Key terms:

Activity one –
 Savings: The money that households and businesses
securities and do not spend on consumption or investment.
portfolio  Income: The total amount of money that households
receive from businesses in the form of wages, rent,
management: interest, and profits.
 Taxes: The money that households and businesses pay to the government.
 Labour: The work that people do in order to earn an income.
 Services: The work that people do to provide a benefit to others, such as healthcare,
education, and transportation.
 Goods and services: The products that businesses produce and the services that
businesses provide.
 Borrowings and equity: The money that businesses can borrow from banks or
investors in order to finance their production activities.
 Consumption plus net exports: The total amount of spending by households and
businesses on goods and services, both domestically produced and imported.
 Business sector: The part of the economy that produces goods and services.
 Government: The part of the economy that provides public goods and services, such
as national defense, education, and healthcare.
 Households: The part of the economy that consumes goods and services.
 Capital market: The market where businesses can borrow money or issue shares to
investors.
 Rest of the world: This is the rest of the world, including other countries.

ECONOMY
An economy refers to the system of production, distribution, and consumption of goods and
services within a region or a country. It encompasses all the activities related to the creation
and exchange of wealth, resources, and value. Economies are complex and dynamic systems
that involve various interactions, institutions, and agents.
Now that we know the key economical terms let us explore the economy models with
examples:
The above diagram shows the flow of resources in a two sector economy:
What is a two sector economy?
In the two-sector economy, there are only two sectors: households and businesses. It is a
simplified economic model used to demonstrate how goods, services, and income flow
between these two sectors. Although real-world economies are more intricate, the two-sector
model serves as a fundamental tool in comprehending economic interactions.
Components of a two-sector economy
 Household Sector: This sector consists of individuals or households that provide
labor, land, capital, and entrepreneurial skills to the economy. Families supply factors
of production to businesses in exchange for income.
 Business Sector: The business sector includes all firms and enterprises that produce
goods and services using household production factors. Businesses generate revenue
by selling their products to households
The flow of resources in a two-sector economy:
Business Sector
 Savings: The money that businesses do not spend on production is saved. This money
can be used to invest in new businesses or to purchase financial assets.
 Borrowings and equity: Businesses can borrow money from banks or issue shares to
investors in order to finance their production activities.
 Capital market: The capital market is where businesses can borrow money or issue
shares to investors.
Household Sector
 Income: Households earn income from working in businesses or from providing
capital to businesses.
 Consumption expenditure on goods and services: Households use their income to
purchase goods and services produced by businesses.
  Savings: Households can save some of their income for future use. This money can be
invested in financial assets or used to purchase goods and services in the future.
The flow of money: Money flows from businesses to households in the form of wages, rent,
interest, and profits. Money flows from households to businesses in the form of consumption
expenditure.
The flow of goods and services: Goods and services flow from businesses to households in
the form of products. Goods and services flow from households to businesses in the form of
factor services.
The concept of a two-sector economy serves as a basis for understanding the fundamental
exchange of goods, services, and income between households and businesses. It is a starting
point for comprehending more complex economic models that include sectors beyond these,
such as government activities, international trade, financial markets, and other real-world
intricacies.

The above picture shows how the 3-sector economy works

What is 3 sector economy?
A three-sector economy is a more comprehensive economic model than a two-sector
economy, as it introduces an additional sector known as the government sector. In this model,
the economy is divided into three main sectors: the household sector, the business sector, and
the government sector. Each sector plays a distinct role in the functioning of the economy,
contributing to production, consumption, and overall economic activity.
Components of a 3-sector economy?
 Household Sector: Similar to the two-sector economy, the household sector
consists of individuals or households that provide labor, land, capital, and
entrepreneurial skills to the economy. Families supply factors of production to
businesses and receive income in return.
 Business Sector: This sector includes all firms and enterprises that produce
goods and services using household production factors. Businesses generate
revenue by selling their products to households and other businesses.
 Government Sector: The government sector represents the public sector,
which includes government entities at various levels (local, regional, and
national). The government sector plays a role in economic activity through
taxation, spending, and policy-making.
The flow of resources in a 3-sector economy
 The flow of money: Money flows from businesses to households in the form of
wages, rent, interest, and profits. Money flows from households to businesses in the
form of consumption expenditure. Money flows from households to the government
in the form of taxes. Money flows from the government to businesses in the form of
government purchases. Money flows from the government to households in the form
of transfer payments, such as Social Security and welfare.
 The flow of goods and services: Goods and services flow from businesses to
households in the form of products. Goods and services flow from households to
businesses in the form of factor services. Goods and services flow from the
government to households in the form of public goods and services.
Example of a three-sector economy :
A closed economy like China [ during ’60s] is an example of a 3 sector economy without a
presence of foreign forces.
The three-sector economy model is a more realistic model of the real economy than the two-
sector economy model. It includes the government sector, which plays an important role in
the economy. The government sector can provide fiscal stimulus to the economy by
increasing government purchases or by reducing taxes. The government sector can also
provide monetary stimulus to the economy by increasing the money supply.
What is a four sector economy?
A four-sector economy is an economic model that includes four main sectors or components:
households, businesses, government, and the foreign sector. Each sector represents a distinct
category of economic activity and interaction. The addition of the foreign sector distinguishes
the four-sector economy from simpler models like the two-sector and three-sector economies.
Components of a four sector economy

Household Sector:
 Individuals and families constitute the household sector.
 Households supply labor, capital, land, and entrepreneurial skills to the economy.
 They receive income in the form of wages, salaries, rent, interest, and profits for their
contributions.
 Households use this income to meet their consumption needs, save, and invest.
 Business Sector:
 The business sector comprises firms and enterprises engaged in production.
 Businesses utilize the factors of production provided by households to produce goods
and services.
 They generate revenue by selling products to households, other businesses, the
government, and foreign buyers.
  The sector creates employment opportunities and contributes to economic growth.
 Government Sector:
 The government sector includes government entities at different levels (local,
regional, national).
 Governments collect taxes from households and businesses to finance public goods
and services.
 They provide essential services such as education, healthcare, infrastructure, and
defense.
 The government sector also implements regulations and economic policies to
influence the economy.
 Foreign Sector:
 The foreign sector represents interactions with the global economy.
 It involves international trade, foreign investments, and financial transactions.
 Exports and imports of goods and services occur between the domestic economy and
foreign countries.
 The sector affects the economy through exchange rates, trade agreements, and
economic conditions in other countries.
Flow of resources in a four sector economy:
 The flow of money: Money flows from businesses to households in the form of wages,
rent, interest, and profits. Money flows from households to businesses in the form of
consumption expenditure. Money flows from households to the government in the
form of taxes. Money flows from the government to businesses in the form of
government purchases. Money flows from the government to households in the form
of transfer payments. Money flows from businesses to the foreign sector in the form
of exports. Money flows from households and businesses to the foreign sector in the
form of imports.
 The flow of goods and services: Goods and services flow from businesses to
households in the form of products. Goods and services flow from households to
businesses in the form of factor services. Goods and services flow from the
government to households in the form of public goods and services. Goods and
services flow from businesses to the foreign sector in the form of exports. Goods and
services flow from households and businesses to the foreign sector in the form of
imports.

Example of 4 sector economy

most of economies around the world are examples of this like India, USA, UK etc.
Now that we know the types of economy let us compare them for a better understanding. We
can differentiate the economy types based on the following features:
Aspect Two-Sector Three-Sector Four-Sector
Economy Economy Economy
Number of 1. Household 1. Household 1. Household
Sectors Sector Sector Sector
2. Business 2. Business 2. Business Sector
Sector Sector
3. Government
3. Government Sector
Sector
4. Foreign Sector
Focus Basic Production, Domestic and
production consumption, global interactions,
and and government production,
consumption involvement consumption, and
government
involvement
Government Not included Included Included
Sector
Government Not Provides public Provides public
Role applicable services, enacts services, enacts
policies, and policies, regulates
regulates economic activities,
economic and engages in
activities foreign interactions
Economic Not Government Government
Policies influenced by policies affect policies influence
government economy through economic activities
taxation, and global trade
spending, and
regulations
Income Not Government role Government
Redistribution considered in income policies may
redistribution impact income
through social distribution and
programs and social welfare
policies programs
Resource Simple Government Government
Allocation supply and influence on policies influence
demand resource resource allocation
dynamics allocation and and trade
 economic relationships
stability
Complexity Simplified Greater Comprehensive
model complexity due model considering
to government domestic and
involvement international
factors
Analysis Scope Basic Includes Considers
economic economic economic
interactions activities, interactions,
policies, and policies, and global
regulations trade
involving the
government
Decision Simple Consideration of Consideration of
Implications production- government government
consumption policies, public policies, global
decisions services, and trade, and
regulations in international
decision-making economic factors