What is Expenditure Approach?
Definition: The expenditure approach is a method used to measure the Gross Domestic Product of a country. The distinct GDP measuring metric focuses on the amount of money spent within a country’s border. Unlike other methods, the method focuses on consumer consumption as well as government spending and net exports.
The method assumes that the entire spending made in the private sector, made up of consumers and private firms, as well as the government spend, amounts to the total value of goods produced in a given period. Given the outcome results in a nominal GDP, several adjustments are made, taking into consideration inflation levels, consequently resulting in the real GDP.
Calculating the Expenditure Approach Formula
The consumer spending (C), taken into consideration when calculating expenditure, is essentially the amount that a population spends on goods and services. Investment (I), on the other hand, is the amount that businesses owners spend to ensure operational efficiency. It may include the purchase of new equipment as well as the expansion of production capacity.
Government spending (G) denotes the amount of money that a government spends on new infrastructures such as roads and bridges. Net exports (NX), on the other hand, denote the difference between exports and imports that a country makes.
Consequently, the calculation of GDP based on the expenditure model would be
GDP= C + I + G + NX.
Expenditure Approach Example
Assume the consumer spending for country XYZ was $500,000 for the first three months of the year. The government spending, on the other hand, stood at $400,000. Upon carrying out extensive research, a policymaker discovers that fixed investment expenditure in the economy stood at $300,000 made up of $70,000 on machinery purchases, $130,000 on inventory investment, and $100,000 on residential investment.
If the country exported goods worth $400,000 for the period and imported goods worth $300,000, the net exports, in this case, would amount to $400,000-$300,000= $100,000.
Calculation of GDP using the expenditure approach would be:
GDP= C + G + I + NX
XYZ GDP= $500,000 + $400,000 + $300,000 + $100,000= $1.3 million
Understanding the Expenditure Approach Role in GDP Calculation
In most of the biggest economies in the world, the most dominant component in the calculation of GDP under the expenditure approach is consumer spending. The component is often broken down to spending on durable goods such as cars and nondurable goods such as food as well as services.
Government spending comes a close second as it represents expenses made up by state local and federal authorities. Most of these spending goes towards healthcare education as well as weaponry.
Business investment tends to be the most volatile component in the expenditure approach, as it varies depending on the needs of businesses. Investment, in this case, includes spending on real estate equipment as well as production facilities, among others. The net export component, on the other hand, reflects the impact of foreign trade on the overall economy.
Expenditure Method vs. Income Method
The expenditure method and income method are both used to calculate the Gross Domestic Product of a country. However, the two methods differ, given the metrics used in their calculation. While the expenditure method centers on the amount of money spent on services and goods over a given period, the Income method focuses on the amount of money earned in the production those of goods and services.
The income method also assumes that all expenditures spent within an economy is equal to the amount of income generated by the production of goods and services.
Amidst the differences, the expenditure approach remains the most common and practical way of calculating the Gross National Product, which often leads to the real Gross Domestic Product. Economists place more emphasis on the expenditure approach given businesses, governments as well as people willingness to spend money.