Question

4. What is the meaning of this equation: Total Spending (GDP) = C + I + G + (X-M)? What information does this equation try to communicate to us? Why? Why should we care about this information?

5. In theory, what is so ‘unique’ and ‘special’ about Business Spending (I)? One can argue that this area of spending is MUCH MORE IMPORTANT than “just 17% of Total Spending”---why may this be true?

6. In theory, what must a firm be thinking in order to START the process of building factory #5? How and when and why might the firm give itself “the green light”??

Answer 1

4) The equation means that the total spending in the economy is a summation of spending on final consumption, the spending on private and government investment and the net exports. This is the most fundamental information about the economy as it tells us about the GDP of the country i.e the total spending on the domestically produced goods and how it is growing. Only if the GDP is growing at a good rate, the economy of the country is able to produce jobs and livelihood for the ever-growing population

5) Business spending has a long term role in the economy. A lot of investment has gestation periods during which no returns are earned but which can be profitable in the long term. Thus, it is much more important than just saying that it constitutes 17% of total spending as it contributes to growth in the long term. Since a lot of investment works on the basis of expectation about the economy, it is also a good starting point to understand the future outlook.

6) The firm has to be able to make profits in order to start the process of building a factory. Its revenues have to exceed the cost of production.

7) The firm may give itself a green light when it can estimate a fairly robust demand for the product it intends to make and that it can capture a significant market share. Supply chain linkages are extremely important to maintain a constany supply of raw materials which needs to be ensured as well.