What is the 'Expenditure Method'

The expenditure method is a system for calculating gross domestic product (GDP) that combines consumption, investment, government spending and net exports. It is the most common way to estimate GDP, and it says everything that the private sector, including consumers and private firms, and government spend within the borders of a particular country, must add up to the total value of all finished goods and services produced over a certain period of time. This method produces nominal GDP, which must then be adjusted for inflation to result in the real GDP.

BREAKING DOWN 'Expenditure Method'

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.

Main Components Under Expenditure Method

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.

Limitation of GDP Measure

GDP, 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.

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