Theory of economics

Expenditure Approach

The expenditure approach, expenditure method, or output approach is a way to calculate gross domestic product (GDP).

It combines consumption, government spending, investment, and net exports. Essentially, the expenditure approach dictates that everything that both the private sector and government spend within a certain country must add up to the total value of all finished goods and services produced in a certain period of time. Total spending should equal to total production. Distinct from the income approach, the expenditure approach is the most common method for calculating GDP (nominal GDP), which can then be adjusted for inflation in order to arrive at real GDP. The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output takes all the different areas in which money is spent within the region, and then combines them to find the total output.The expenditure approach attempts to calculate GDP by evaluating the sum of all final good and services purchased in an economy.

Formula⁵: Y = C + I + G + (X – M); where: C = household consumption expenditures / personal consumption expenditures, I = gross private domestic investment, G = government consumption and gross investment expenditures, X = gross exports of goods and services, and M = gross imports of goods and services.

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  “C” (consumption) is normally the largest GDP component in the economy, consisting of private expenditures (household final consumption expenditure) in the economy. Personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services.
  
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  “I” (investment) includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Spending by households (not government) on new houses is also included in Investment. “Investment” in GDP does not mean purchases of financial products. It is important to note that buying financial products is classed as ‘ saving,’ as opposed to investment.
  

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  “G” (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. However, since GDP is a measure of productivity, transfer payments made by the government are not counted because these payment do not reflect a purchase by the government, rather a movement of income. They are captured in “C” when the payments are spent.
  
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  “X” (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations’ consumption, therefore exports are added.
  
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  “M” (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms “G”, “I”, or “C”, and must be deducted to avoid counting foreign supply as domestic.
  

The purpose of the expenditure approach is to calculate GDP in terms of the amount of money spent within a country’s borders.

It is the most widely used method for calculating GDP, by totaling four principal expenditures:

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  Consumptionbyhouseholds
  
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  Government spending on goods and services
  
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  Businessinvestment
  
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  Netexports
  

Since expenditure is a symptom of and synonymous with demand, an increase in aggregate demand will always be seen within the expenditure approach as both will ultimately show an increase in GDP.The expenditure method is the more common approach and is calculated by adding total consumption, investment, government spending, and net exports.