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

Definition: Spending that leaks out of the circular flow through taxes, savings and imports Ignores Leakages

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.