GDP Formula
 Consumption (C) + Investment (I) + Government
Purchases/Spending (G) and Net Export (X)
Consumption
 Spending on goods and services
 Buying durable goods (cars and appliances) and
nondurable goods (food and clothing)
 Receiving services such as haircuts and dental care
Investment
 Consumers are not the only one spending money
 Firms purchase capital equipment, inventories and
factories
 Definition: creation of capital goods to increase future
production. Examples include: machines and tools
whose purpose is to produce other goods
Government Spending
 Government also spend money on products and
services too
 Spending at local, provincial or federal level
 Includes salaries of government workers and spending
on public works
Net Exports
 Exports – Imports
 Foreigners also spend money too when they purchase
Canadian goods
 Consumers spend
money to purchase
products and services
 Companies use the
money to pay workers
to produce products
and services
ASSUMPTIONS
 It is assumed that
whatever spent will
come back in form of
income
 It is assumed that any
form of income will
be spent on products
and services
Simple Circular Flow
 It is assumed that there is equality between the two
sides
 Thus: Aggregate (total) spending = Aggregate Income
 What is the flaw behind this assumption?
Flaw
Ignores Leakages
 Definition: Spending that leaks out of the circular flow
through taxes, savings and imports
Flaws
 Diagram ignores leakages & banks excessive lending to
the public
 Both can lead to an imbalance
Fiscal Policy
 Fiscal policy is the use of taxation and government
spending to influence the economy
 Fiscal policy is used to help counter the bust and boom
of business cycles, keeping the economy moving
steadily on the road towards potential GDP, full
employment and stables prices.