The Circle Money Travels: GDP

In micro, the story was one cafe's sales. In macro, all spending in a country forms one big circle.

Households spend, firms invest, and the government spends. Add what foreigners buy from us, minus what we buy from them. The total is GDP — the sum in the formula below. The circle keeps turning when 💰 money flowing in matches money leaking out.

For example, imagine 30 🧑 classmates each spend a 10,000-won allowance at the corner 🏪 snack bar every month. The owner buys ingredients with that money and drops the rest in a 🐷 piggy bank. Adding up everything the class spent gives the class its own tiny GDP.

GDP=C+I+G+NXGDP = C + I + G + NX
S+T+M=I+G+XS + T + M = I + G + X

Part of these learning paths

Examples & Exercises

An economy has consumption C=300C = 300, investment I=120I = 120, government spending G=110G = 110, and net exports NX=−30NX = -30.

What is GDP, and which piece is biggest?

The default setup — a 500500 GDP economy.
Show proof

  1. GDP adds up all the spending going around the circle: 300+120+110−30=500300 + 120 + 110 - 30 = 500. Net exports are negative because imports beat exports, so that much leaked out of the circle.

  2. The biggest piece is consumption: 300/500=60%300 / 500 = 60\%. In real countries, too, consumption usually takes well over half of GDP.

An export boom lifts net exports from NX=−30NX = -30 to NX=20NX = 20.

If nothing else moves, how much does GDP change?

Only net exports at 2020 — everything else default.
Show proof

  1. The new GDP is 300+120+110+20=550300 + 120 + 110 + 20 = 550. Against the old 500500 that is exactly 5050 more, a 10%10\% rise.

  2. Since no other piece moved, ΔGDP=ΔNX=50\Delta GDP = \Delta NX = 50. Inside the identity, one piece's change lands on GDP one-for-one.

    (The story of how it can grow bigger through the multiplier comes in a later chapter.)

1. The Macro Lens