Expenditure Method

• Expenditure Method
• The expenditure method measures a country’s Gross Domestic Product (GDP) by incorporating
imports, exports, investments, consumption, and government spending. The expenditure method can
be regarded as the frequently used method to measure GDP.
• According to the expenditure method, both private and public sector expenses incurred within a
country’s borders will give the total production value of finished goods and services over some time.
It gives the nominal GDP, which is adjusted for inflation to arrive at the actual GDP. The income
approach is another way to calculate GDP.
• Expenditure Formula
• There are primarily four different types of aggregated expenses that are utilized to determine GDP.
These are –
1.Investments made by businesses.
2.Government expenses on goods and services.
3.Household consumption.
4.Net exports (total exports minus the value of imported goods and services)
• The Expenditure Method Formula is as Follows –
• GDP=C+I+G+(X–M)
 • 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 the government’s spending on goods and services provided to the public, X is
exported, and M is imported.

 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 –
1. 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 nondurable 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.
2. 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.
3. Business Investment – Business investments include capital Expenditures on assets by different
organizations.
• Business investment can be divided into two categories –
a) Gross Fixed Capital – It indicates expenses incurred during the purchase of fixed assets. Gross fixed capital
can be further categorized into two types.
 Gross Business Fixed Investments – These includes expenses made towards long-term assets, such as
machinery, commercial real estate, production facility, infrastructure, etc.
 Gross Residential Construction Investments – Expenses incurred by businesses for purchasing or
constructing residential units upon receiving tenders.
b) 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 items that cannot be
utilized for current consumption. Inventory investment is determined by calculating the closing stock
balance and opening stock balance at the end of each year.
4. Net Exports – The difference in valuation between the exports and imports undertaken by a country within
one financial year is considered net exports. Exports are considered an output of an economy whereas
imports are considered 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.
1. Private Final Consumption Expenditure (PFCE)
• It is a summation of the total final household consumption expenditure and final consumption expenditure of
other private non-profit institutions on various types of consumer goods and services, including durable (except
houses, as any expenditure incurred on the purchase or construction of houses occupied by owners comes
under Gross Residential Construction Investment as Capital Formation), non-durable, semi-durable goods and
services. It also includes all the domestic and international expenditures incurred by citizens of a country. This
means that if a resident of India consumes anything even on foreign land, it will be added up in this component
of expenditure, whereas consumption by a foreigner on Indian land will be subtracted from PFCE.
2. Government Final Consumption Expenditure (GFCE)
• The government spends fortunes on the development and maintenance of various administrative and
infrastructural services like defense, education, roads, law, and order, as well as on various welfare schemes.
Thus, this component measures the expenditure incurred by the government of an economy on these services
for its functioning.
3. Gross Domestic Capital Formation (GDCF)
• It refers to the expenditure incurred in the purchase or addition of capital stock of an economy by the
production unit. It is viewed as an investment made by the production firms on the domestic territory;
therefore, often referred to as Gross Investment. It is further subdivided into two components
namely, a) Gross Fixed Capital Formation and b) Inventory Investment.
a) Gross Fixed Capital Formation: Refers to the expenditure incurred by production units in
acquiring fixed assets (durable goods).
It has three components
I. Gross Business Fixed Investment It includes expenditure in acquiring new machinery, building,
plant, furniture, etc. such goods support production activities for a long time.
II. Gross Residential Fixed Investment on House Construction;- It includes expenditure in
construction and acquiring new houses by households
III. Gross Public (Govt) Fixed Investment;- it includes expenditure on the construction of the public
building, flyovers, bridges, roads, etc., by the government.
2. Inventory Investment (change in Stock) :- It refers to the physical change in the stock of raw
materials, semi-finished goods, and finished goods. It is calculated as the difference between closing
stock – opening stock of the year.
• 4. Net Exports (X – M)
• An economy often trades goods through exports and imports with other economies to take
comparative advantage and promote healthy market competition. Net export is derived as
the difference between the export and import of an economy for a given year. Exports (X)
are the foreign expenditure on the consumption of domestic goods, and since they are
produced on domestic land, it is added to the total output. Imports (M) are the domestic
expenditure incurred from the consumption of foreign goods, as it is produced on foreign
land, they must be excluded from the total output of the domestic economy.
 Precautions of Expenditure Method
1. Expenditure on Intermediate Goods will not be included: To avoid double-counting, expenditure on
intermediate goods and purchase of second-hand goods are not taken into account in the calculation of
National Income using this method, as they do not contribute to the current circular flow of goods and
services.
2. Purchase of Financial Assets will not be included: Procurement of financial assets like debts, bonds,
etc., will not be included as they are a mere tool and not an actual physical good; therefore, they not
contributing in any way to the flow of goods and services. However, any brokerage or commission on the
sale or purchase of such kinds of financial statements is included in the National Income, as it is a
productive service.
3. Transfer Payments are not included: Since transfer payments do not create any value addition in the
economy, nor is it connected to any production activity, it is not included in the National Income
calculation.
4. Purchase of second-hand goods will not be included: Expenditure on second-hand goods has already
been included in the National Income at the time of their initial purchase. Therefore, the purchase of these
types of goods does not affect the circular flow of goods and services of an economy and hence is not
included in the National Income. However, any type of brokerage or commission, even on the purchase of
second-hand goods and financial assets, will be included in the expenditure method.
5. Expenditure on own account production will be included: Expenditure on productive services, like the
imputed value of owner-occupied houses, production of goods or services for self-consumption, free
services from the general government, and private non-profit institutions serving households will be
included in the calculation of National Income of an economy.