how the expenditure method works
expenditure is a reference to spending in economics another term for consumer spending is demand the total spending or demand in the economy is known as aggregate demand this is why the gdp formula is actually the same as the formula for calculating aggregate demand because of this aggregate demand and expenditure gdp must fall or rise in tandem however this similarity isn t technically always present in the real world especially when looking at gdp over the long run short run aggregate demand only measures total output for a single nominal price level or the average of current prices across the entire spectrum of goods and services produced in the economy aggregate demand only equals gdp in the long run after adjusting for price level the expenditure method is the most widely used approach for estimating gdp which is a measure of the economy s output produced within a country s borders irrespective of who owns the means to production the gdp under this method is calculated by summing up all of the expenditures made on final goods and services there are four main aggregate expenditures that go into calculating gdp consumption by households investment by businesses government spending on goods and services and net exports which are equal to exports minus imports of goods and services the formula for expenditure gdp is g d p c i g x m where c consumer spending on goods and services i investor spending on business capital goods g government spending on public goods and services x exports m imports begin aligned gdp c i g x m textbf where c text consumer spending on goods and services i text investor spending on business capital goods g text government spending on public goods and services x text exports m text imports end aligned gdp c i g x m where c consumer spending on goods and servicesi investor spending on business capital goodsg government spending on public goods and servicesx exportsm imports in the united states the most dominant component in the calculations of gdp under the expenditure method is consumer spending which accounts for the majority of u s gdp consumption is typically broken down into purchases of durable goods such as cars and computers nondurable goods such as clothing and food and services the second component is government spending which represents expenditures by state local and federal authorities on defense and nondefense goods and services such as weaponry health care and education business investment is one of the most volatile components that goes into calculating gdp it includes capital expenditures by firms on assets with useful lives of more than one year each such as real estate equipment production facilities and plants the last component included in the expenditure approach is net exports which represents the effect of foreign trade of goods and service on the economy expenditure method vs income methodthe income approach to measuring gross domestic product is based on the accounting reality that all expenditures in an economy should equal the total income generated by the production of all economic goods and services it also assumes that there are four major factors of production in an economy and that all revenues must go to one of these four sources therefore by adding all of the sources of income together a quick estimate can be made of the total productive value of economic activity over a period adjustments must then be made for taxes depreciation and foreign factor payments the major distinction between each approach is its starting point the expenditure approach begins with the money spent on goods and services conversely the income approach starts with the income earned wages rents interest profits from the production of goods and services limitation of gdp measurementsgdp which can be calculated using numerous methods including the expenditure approach is supposed to measure a country s standard of living and economic health critics such as the nobel prize winning economist joseph stiglitz caution that gdp should not be taken as an all encompassing indicator of a society s well being since it ignores important factors that make people happy for example while gdp includes monetary spending by private and government sectors it does not consider work life balance or the quality of interpersonal relationships in a given country 