For an economy as a whole, total income must equal total expenditure.
1. If someone pays someone else $100 to mow a lawn, the expenditure on the lawn service ($100) is exactly equal to the income earned from the production of the lawn service ($100).
2. We can also use the circular flow diagram from Chapter 2 to show why total income and total expenditure must be equal.
a. Households buy goods and services from firms; firms use this money to pay for resources purchased from households.
b. In the simple economy described by this circular flow diagram, calculating GDP could be done by adding up the total purchases of households or summing total income earned by households.
c. Note that this simple diagram is somewhat unrealistic as it omits saving, taxes, government purchases and investment purchases by firms. However, because a transaction always has a buyer and a seller, total expenditure in the economy must be equal to total income.