Short & Simple 4 – Total Spending Equals Total Income

We saw in parts 2 and 3 that funds initially enter the economy through either government spending or bank lending. In the future, we will take a closer look at these activities. For now, it is enough to understand that these funds, once created, can be used for various purposes, including spending.

‘Spending’ is the act of buying a good or service. The amount spent goes to somebody else as ‘income’, which is the amount received when a good or service is sold.

Since every act of spending results in income for somebody else, total spending for the economy as a whole equals total income. This is true by definition and is a basic building block in macroeconomics.

By total spending is meant all the spending on goods and services that occurs within a certain period of time, such as a year. Similarly, total income is all the income received from the sale of goods and services within the same time frame.

Because of the centrality of spending and income, the phrase ‘goods and services’ comes up frequently as well.

A ‘good’ is a physical product of some kind. It is a physical thing. It might be a new car, a computer, a pack of chewing gum or a machine designed for use in a factory. And, of course, there are many other goods produced in the economy.

A ‘service’ is an activity undertaken for the benefit of others. There are many kinds of services. To mention just a handful, there are administration, cleaning, transport, utilities, child and aged care, health care and education. The ‘labor services’ performed by workers and managers in exchange for wage or salary income are fundamental to production.

Spending and the receipt of income occur every time a good or service is bought and sold.

For instance, when a customer buys a loaf of bread at a convenience store, the amount paid by the customer goes to the store owner as income.

Similarly, when a business pays wages to its staff, this spending on labor services is received by staff as income.

More generally, the spender could be from:

  • the domestic government sector, which includes federal, state and local governments as well as public sector organizations;
  • the domestic private sector, which is made up of private businesses and households; or
  • the rest of the world (also called the foreign or external) sector, since foreign individuals, businesses and governments can buy goods and services produced in the domestic economy.

Equally, the seller of a good or service can come from any of these three sectors, although government frequently supplies its goods and services through non-market means, such as when it provides free public schooling or toll-free roads and other infrastructure.

No matter what the spending, and no matter who does the spending, the amount spent will go to somebody else as income.

This is why total spending always equals total income.

10 thoughts on “Short & Simple 4 – Total Spending Equals Total Income

  1. “‘Spending’ is the act of buying a good or service.”

    I think that probably doesn’t help get past the problem of focussing on the money, and not on the act of purchase. It’s like the humpty dumpty definitions of inflation. People think of spending involving coins or some traditional monetary item. The redefinition in economics is probably deliberately confusing. And economics is full of that sort of trick.

    The act of buying a good or service is actually placing an order. That generates a debt – credit. Everybody does that until they run out of credit or things they want to buy – whichever comes first. Most business is done on business credit.

    So Total Orders = Total Income.

    The spending bit is then the swapping of debts around until everybody has the type of monetary liquidity they want. Hence the difference between income and cash flow.

    Simplifying is always hard and your articles are always some of the best, but I wonder if we can find a way of doing it while respecting more common parlance rather than further embedding economic definition triangulation tricks.

  2. I don’t know whether I am ‘right’ or wrong’ about this, but since reading about MMT I always think of human beings wandering out of Africa, or kids playing in a schoolyard: – ‘money’ is simply a record of who owes who what. After that, like in so many ways, we make it complicated. It does seem to blow a fuse in people’s minds when you tell them money is not actually substantial, but an in the moment human relation (although the chimps have a version)! The essential thing about a credit is whether or not it does harm. The essential thing about a human being is whether we feed the ‘good wolf or the bad wolf’. The good news is (when the basic needs are looked after) you are rich when you feel rich; and poor when you feel poor, no matter how many credits you have inked on your balance sheet.

    So Total Credits = Total Problems or Total Expectations … 🙂

  3. What about total costs, and if they exceed total individual incomes does that not make borrowing necessary and hence the continual build up of debt?

  4. Hi Steven. This rule applies in total. All the spending in the period equals all the income.

    But an individual’s spending can differ from his or her income. As you correctly note, an individual can spend more than income through borrowing (and, of course, can spend less than income, too). . Any subset (or ‘sector’) of society can spend differently from its income. It’s only for the economy as a whole that the rule applies: total spending equals total income.

    We will get to these distinctions later in this “short & simple” category of posts. For now, if you haven’t seen it already, you might find an earlier post useful in relation to your question. It is still at a pretty introductory level, but a bit more difficult than the short & simple ones are intended to be.

    Budget Deficits and Net Private Saving

  5. Macro for dummies
    Comment on heteconomist on ‘Short & Simple ― Total Spending Equals Total Income’

    The heteconomist Peter Cooper says: “Since every act of spending results in income for somebody else, total spending for the economy as a whole equals total income. This is true by definition and is a basic building block in macroeconomics.” (See intro)

    Both, orthodox and heterodox economists subscribe to this statement as the self-evident rock bottom truth of all of economics. Too bad that this statement is materially/logically false.

    The foundational error/mistake/blunder consists in the methodological fact that the two most important magnitudes of economics — profit and income — are ill-defined.#1 In order to see this one has to go back to the MOST ELEMENTARY configuration, that is, the pure consumption economy which consists only of the household and the business sector.#2

    In this elementary economy, three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.

    In case (i) the monetary saving of the household sector Sm≡Yw-C is zero and the monetary profit of the business sector Qm≡C-Yw, too, is zero. The product market is cleared, i.e. X=O.

    In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.

    In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

    It always holds Qm+Sm=0 or Qm=-Sm, in other words, at the heart of the monetary circuit is an identity: the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law. It follows directly from the profit definition Qm≡C-Yw and the definition of household sector saving Sm≡Yw-C.

    Loss or profit are NOT income. Only distributed profit is income. The profit theory is false since Adam Smith.#3

    Egmont Kakarot-Handtke

    #1 For details see ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down’
    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2705395
    and ‘Keynes’s Missing Axioms’ Sec. 14-18
    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1841408
    #2 The elementary consumption economy is given by three systemic axioms: (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.
    #3 See ‘Essentials of Constructive Heterodoxy: Profit’
    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2575110
    and cross-references Profit
    http://axecorg.blogspot.de/2015/03/profit-cross-references.html

  6. Total Contracting = Total Contracting – This makes money in the first instance a communications device. However, because money is also a form of measurement this builds in an “antagonism” because the unit of measurement is flexible (No intrinsic or firm value. Money merely has “valuableness.”) This flexibility means it can be manipulated for selfish reasons.

  7. The point of using the equation Total Contracting = Total Contracting is merely to highlight that we use money as a communication device to contract with each other for the goods and services we need then comes the sub-division exercise of breaking its use down into the categories of income, profit, savings, etc.

    Because money has variable value and not intrinsic value that results in it having a built-in “antagonism” namely that it can be manipulated for selfish-purposes. This means the Neo-Liberal or Hayekian argument that every effort should be made to keep government out of regulating markets doesn’t hold. In their joint article “Guiding The Invisible Hand” Abba Lerner and David Colander basically argued that government should have a role as “Institutional Entrepreneurs” to correct market failures and clearly correcting an “in-built antagonism” in money is one standing justification.

    http://community.middlebury.edu/~colander/articles/guiding%20the%20invisible%20hand.pdf

  8. @peterc,

    I’m referring to the macro-economic flow of individual incomes in ratio to total costs. The more concrete fixed capital/development we create the more additional costs we create due to depreciation, obsolescence and waste, over and above the credit created to create that development itself. This is a cost accounting observation of the most basic disequilibrating factor in modern developed economies and needs to be addressed. As Steve Keen has observed economists can get their PhD in economics without so much as taking an elementary course in accounting. It’s a weakness in current theorizing. In fact Keen himself, dispite being a disequilibrium theorist, is still caught up in accounting equilibriums and so misses the above cost accounting reality.

  9. Steven, sorry for misinterpreting your point.

    The ‘total spending equals total income’ identity does not imply equilibrium.

    This is not to say that your point is uninteresting. It seems reminiscent of Marx’s falling profit rate ‘law’, in which he argued that the investment dollars flowing into plant, equipment and materials typically rise in proportion to the dollars flowing into wage and salary payments during an expansionary phase of capitalist development. For given distribution, this tends to reduce the average rate of profit (because income or value falls relative to total cost or constant plus variable capital). In Marx’s view, this sows the seeds of the next crisis. One way this could be precipitated is for the rate of income (or value) creation to fall below the level needed to service debt.

    These ideas are a bit outside the scope of the present post, which is intended for beginners. Even if I agreed that the point you emphasize should be a basic building block of macro, introductory material is not really the place to reconstruct theory. This needs to be done at a more advanced level before being reflected in introductory materials.

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