Under the expenditure approach, gross domestic product (GDP) equals the sum of all spending on final goods and services in a country during a certain period.
This is one of the three approaches to calculating GDP. The other two are:
- Income approach
- Output / production approach
In theory, all three must produce the same number. However, economic inequality often arises because of inaccurate data sources and collection methods. We call this error a statistical discrepancy.
Formula of expenditure approach GDP
GDP is the total expenditure of four macroeconomic sectors:
- Household sector
- Business sector
- Government sector
- External sector
The external sector represents net expenditure by foreigners. Not all goods and services produced in the country are for domestic consumption. Some products go abroad to meet demands from foreigners. Likewise, the domestic economy also needs to import some goods that are not produced domestically.
Well, here is the formula for calculating GDP using the expenditure approach:
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GDP = C + I + G + (X-M)
Where:
- C = consumption expenditure
- I = gross private domestic investment
- G = government expenditure
- X = export
- M = import
Consumption expenditure covers household purchases of goods. It consists of spending on durable goods, nondurable goods, and services. In some countries, this component accounts for the majority of GDP.
The gross domestic private investment consists of investment in capital goods and changes in inventories. Spending by households on new homes also falls into this category.
Government expenses include routine expenses – such as civil servants’ salaries, purchases of weapons for the military – and investment expenses. But, it does not cover transfer payments because they don’t involve exchanging goods and services.
Exports represent foreign demand for domestic products and services. Please remember, GDP captures the value of production of goods and services domestically. Hence, in the equation, exports are positive.
Imports represent domestic spending on foreign products and services. Because the product is not from domestic production, import sign is negative.
