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In August I will be travelling with a friend through Spain, we will fly into Barcelona and want to end up in Madrid, seeing the sights along the way. We may go by car or opt for public transport, depending on which is recommended. We definitely want to get the most out of Barselona and then Madrid, but are seeking recommendations for the best route and the best way to travel around. We wouldn't mind stopping off in Valencia, Granada and / or Seville, depending on which is the city most worth seeing. Any recommendations on routes, places to see and stay would be much much appreciated. We have a low budget so please keep in mind when recommending 
8 days in spain
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Valencia, Granada and / or Seville are not along the route between Barcelona and Madrid.
With 8 days and you HAVE to do both cities. Then just do that. You will not regret it.
You can the high speed train to fly between Madrid and Barcelona. Eight days you should not do anything else.
Train it in snd around Barcelona and to Madrid. Use buses and trains outside Madrid and you can walk most of central Madrid
In August you will be hot, stay near fountains and try to make sure you have a hotel room to sleep the lunch hour away leaving you to stay up late
Um, first you need a map of Spain. Barcelona is in the far north and Madrid in the Center.
Andalusia (Seville, Granada and Crodoba are far in the south).
In the very few days you hae you will have trouble seeing much in Barcelona and Madrid - never mind heading off ot entirely differnt parts of the country.
In many cases, less is more.
You have time, fund, comfort, and destination constraints. It forms an equilibrium where trying to save in in area, for example the fund, will penalize you in other areas you don't have excess resources. What this points is need to control the scope of your trip.
How does one go about estimating the scope of the trip achievable within your constraints?
I think it would benefit to have resources to obtain how much of the constrained resources you are using.
For car, get rental cost quotes from any of the car rental web sites. www.autoeurope.com is one such site.
The get car operating expenses estimate from routing site such as www.viamichelin.com. You can also get travel time estimate, another one of your constrained resources, from here or from Google Maps.
On top of this, add parking cost, one of the many big city related expenses. €25/night if you don't have any idea.
For trains, you can use www.renfe.es to get the cost and the travel time. Buses are usually cheaper, but takes longer if the routes parallel railroads. Use www.movelia.es to get ideas. For example Alsa operates Barcelona to Madrid by bus, but takes almost 8hrs vs. 4hrs by train. Bus costs €30 vs. trains at about €120 non discounted (€50 non refundable discounted advance payment). When my daughter did a term in Spain, she took overnight buses for long distance trips to save money and time but at the expense of comfort. For example, there is 23:00 Barcelona departure, arriving Madrid at 6:50am.
For longer segment, flying is a possibility if used strategically. www.vueling.com is convenient from Barcelona.
You can easily get hotel/hostel prices using their web sites.
Once you have a handle on the scope of the achievable trips, others can probably help you better with how to connect destinations. Right now, you are asking the details of a building before deciding just how big the building is going to be.