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.