2.1 The Circular Flow and GDP
GDP is the market value of all final goods and services produced within a country in a year; the circular flow shows why total spending equals total income.
The circular flow model links households and firms through two markets: households sell resources in the factor market and earn income, then spend it on output in the product market. Every dollar of spending is a dollar of someone's income, which is why GDP can be measured by adding up either spending or income and get the same total.
Gross domestic product is the market value of all FINAL goods and services produced within a country's borders in a year. The expenditure approach adds the four spending components: GDP = C + I + G + Xn (consumption, gross private investment, government purchases, and net exports = exports − imports).
Know the exclusions cold: intermediate goods (already counted in final prices), used goods (not current production), purely financial transactions like stock trades, transfer payments such as Social Security, and nonmarket production. In GDP, 'investment' means business spending on capital and inventories plus new construction — never buying stocks or bonds.
Key terms for 2.1
Practice the math
Counting transfer payments, used-good sales, or stock purchases in GDP. GDP only counts current production of final goods and services — transfers and financial transactions produce nothing new.
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