Students are taught that the macroeconomic income determination system can be thought of as a bath tub with the current GDP being the water level. The drain plug can be thought of as saving, imports and taxation payments (the so-called leakages from the expenditure system) while the taps can be thought of as investment, government spending and exports (the so-called exogenous injections into the spending system). This analogy is valid because GDP will be unchanged as long as the flows into the bath are equal to the flows out of it which is tantamount to saying the the spending gap left by the leakages is always filled by the injections.
Answer: False
The answer is False.
This is actually an example that has been used in the past by macroeconomics teachers to try to teach students the so-called circular expenditure models with leakages and injections.
The basic flaw is that it confuses stocks and flows. It is crucial to a wider understanding of macroeconomics that the distinction between the two concepts is clear in your mind.
The taps and the drains are conceptually accurate because they relate to flows - all expenditure components, saving and taxation payments are flows which are measures as so many $s per period.
A stock has no such time dimension and the only way we can measure it is to take a snapshot at some point in time.
The flaw then relates to the construction of GDP as the level of water in the bath. This is a stock rather than a flow. In the same way as a reservoir is a storage of water which might be 70 or 80 percent full.
But GDP is just the summation of the expenditure flows and is thus a flow itself.
When the national statistician releases the National Accounts and says that GDP was $x billion in the December quarter, they are referring to the sum total of the flow of component expenditure over the 3 month period (October, November, December). They are not referring to a stock of output (which would be inventories or something like that).
The aspect of the question that is true, however, relates to the statement that GDP will be unchanged as long as the flows into the bath are equal to the flows out of it which is tantamount to saying the the spending gap left by the leakages is always filled by the injections.
However the nuance is that it will be the flow of GDP that will be unchanged. The water level is a poor construction of this flow concept.
If we wanted to be aquatic, it would be better to think about a river flowing along with tributaries flowing in and out which alter the water level as it flows along.
That is enough for today!
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