The Expenditure method is a system used for determining the Gross Domestic Product (GDP) of a country. This method considers consumption, investments, net export, and government Expenditure to calculate a nation’s annual GDP.
Expenditure method of National Income can be considered as the most common way to calculate GDP as it includes both public and private sector expenses incurred within a nation’s borders. However, this system can only be used to calculate nominal GDP, which is not adjusted for inflation.
Do you know: This method is also often referred to as the ‘Income Disposal Method’.
How is GDP Determined?
The process of calculating GDP with the Expenditure process is similar to that of determining demand as the total spending of an economy is considered as aggregate demand. For which reason, both Expenditure and aggregate demand shifts in tandem with each other.
However, aggregate demand usually considers the average price of all goods and services produced and utilized in an economy. That makes it similar to GDP only in the long run, after adjusting for inflation.
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Expenditure Formula
There are primarily four different types of aggregated expenses that are utilized to determine GDP. These are –
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Investments made by businesses.
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Government expenses on goods and services.
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Household consumption.
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Net export (total exports minus the value of imported goods and services).
The Expenditure Method Formula is as Following –
[GDP = C + I + G + (X – M)]
Here, C is consumer spending on different goods and services, I represents investments made by businesses, and on capital goods, G represents government’s spending on goods and services provided to the public, X is exports, and M is imports.
Task for you: With the above mentioned Expenditure formula, determine India’s GDP for the financial year of 2018-2019
Primary Components Used in Expenditure Method of Calculating National Income
The above mentioned types of aggregated expenses can be further broken down depending on the parameters these include. Let’s take a look –
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Consumer Spending – Consumer spending usually accounts for a large part of a nation’s GDP. It can be divided into two categories – purchases of durable and non-durable goods, and procurement of services.
Consumer spending includes expenses incurred by individuals residing within the domestic territory, or abroad. For example, expenses made during one’s foreign travel will also be added to consumer spending.
However, it does not include any expenses incurred by foreign visitors in India.
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Government Expenditure – It represents expenses undertaken by both State and Central authorities for providing infrastructure, essential commodities, and other requirements to the general populace. Expenditure method of measuring National Income also includes expenses made towards education, healthcare, and defence industry.
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Business Investment – Business investments include capital Expenditures on assets by different organizations.
Business investment can be divided into two categories –
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Gross Fixed Capital – It indicates expenses incurred during purchase of fixed assets. Gross fixed capital can be further categorised into two types.
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Gross Business Fixed Investments – It includes expenses made towards long-term assets, such as machinery, real-estate, production facility, infrastructure, etc.
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Gross Residential Construction Investments – Expenses incurred by businesses for purchasing or constructing residential units upon receiving tenders.
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Inventory Investment – Investments made towards the acquisition of raw materials, semi-finished or finished goods are included in this category of Expenditure. These are considered as items that cannot be utilised for current consumption. Inventory investment is determined by calculating the closing stock balance and opening stock balance at the end of each year.
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Net Exports – The difference in valuation between the exports and imports undertaken by a country within one financial year is considered as net exports. Exports are considered an output of an economy whereas imports are considered as Expenditures as they are not produced within a country’s National boundaries. Instead of calculating these factors separately, the difference is considered as the net export.
Task for you: Can you categorize the goods and services that India exports overseas? Name the five most high-volume export items.
Precautions Considered While Using Expenditure Method of National Income
Students should keep in mind several factors while using the Expenditure method of calculating National Income. These include –
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Any expenses on account of intermediate goods cannot be considered to determine a nation’s Income as these expenses are already included in the value of final goods produced. Otherwise, it will lead to double-counting of a single Expenditure, thus inflating National Income inaccurately.
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Any transfer payment should not be included under the Expenditure formula as these payments do not add any value to a nation’s economy.
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Purchase of any second-hand goods is not included in the total Expenditure method as these do not affect the total value of goods and services produced. However, any brokerage paid on the purchase of such goods or services has to be included in the calculation.
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Procurement of assets such as shares, bonds, debentures, etc. is also not included in the calculation as these represent changes in ownership instead of changes in goods and services’ values. Contrarily, any brokerage earned on the trading of shares will be considered as a productive service.
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Any expenses incurred due to producing goods for self-consumption, services provided by the government and non-profit institutions (that serve households) are also included in the National Income. Moreover, imputed values of occupied residential units are also considered as a productive service; hence those are considered in the National Income.
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Expenditure Method
Students must have understood the Expenditure method, how is GDP determined, the formula, primary components and the precautions that are taken while calculating.
Since it is a mix of theory and practical, students are advised to follow an effective strategy for preparation so that they are able to achieve the goals in terms of marks that they have set for themselves.
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