Learn About Expenditure Approach in Business: Expenditure Method Formula and How to Calculate GDP

The expenditure approach, expenditure method, or output approach is a way to calculate gross domestic product (GDP).

It combines consumption, government spending, investment, and net exports. Essentially, the expenditure approach dictates that everything that both the private sector and government spend within a certain country must add up to the total value of all finished goods and services produced in a certain period of time. Total spending should equal to total production. Distinct from the income approach, the expenditure approach is the most common method for calculating GDP (nominal GDP), which can then be adjusted for inflation in order to arrive at real GDP.

The purpose of the expenditure approach is to calculate GDP in terms of the amount of money spent within a country’s borders.

It is the most widely used method for calculating GDP, by totaling four principal expenditures:

• Consumption by households
• Government spending on goods and services
• Business investment
• Net exports

Since expenditure is a symptom of and synonymous with demand, an increase in aggregate demand will always be seen within the expenditure approach as both will ultimately show an increase in GDP.

GDP, or gross domestic product, measures the total economic value of all final goods and services a country produces within its borders during a specific time period. An expression of an economy’s relative health—an increase in GDP indicates a country’s economy is growing and a decrease that it is shrinking—GDP is used by economic policymakers, in the United States, and across the world, to determine interest rates and other economic policy.
There are two ways of measuring GDP calculated by the bureau of economic analysis:

• Nominal GDP is a country’s economic output at current total market prices, meaning that it is often shaped as much by currency inflation as it is by increased economic output. Learn more about nominal GDP here.
• Real GDP is a country’s output adjusted for inflation. By comparing the year under study to a base year and keeping prices consistent across both, economists isolate and then remove inflation from the equation, providing a more accurate picture of a nation’s actual increases or decreases in economic output. Learn more about real GDP here.

Generally, an increasing GDP is a sign of economic growth, increased economic activity, and economic well-being, as well as an improved standard of living. For this reason, the U.S. GDP is heavily influential in national and international economic policy.

The expenditure method is used to calculate GDP by considering consumer, investor, and government spending as well as exports and imports. This can be expressed in a mathematical formula:

GDP=C+I+G+(X−M)

In this formula:

• GDP=Gross National Product or national income
• C=Consumer spending on goods and services (final consumption expenditure or personal consumption)
• I=Investor spending on business capital goods (gross investment)
• G=Government spending on public goods and services (government consumption)
• X=Exports of goods
• M=Imports of goods

Essentially, the formula finds the difference between exports and imports (gross value), and adds this net difference to the total amount spent by consumers, government, and investors to arrive at a nation’s gross national product.

Among the components of this formula:

• Consumer spending (particularly in the U.S.) makes up the vast majority of total expenditures. Consumer spending is traditionally broken down into two further categories, durable goods (like computers or a toolbox) and non-durable goods (such as food and socks).
• Government expenditures and government purchases are the second largest contributor to GDP as calculated by the expenditure method, including, state, local, and federal expenditures. Some of these expenditures are defense-related, others like health care, social security, and education are not.
• Investmentment spending is the most volatile and irregular category. It includes expenditures by firms on assets with useful lives for more than one year such as real estate, production facilities, plants, equipment, and the purchase of machinery.
• Net exports calculates the difference between the number of goods imported and exported. It represents the foreign trade of goods and services within the country.

While both the expenditures approach and the income approach are used to calculate GDP, there are key differences between the two:

• The expenditure method assumes GDP to be equal to the total amount of money spent on goods and services within a nation’s borders.
• The income method calculates GDP in terms of the amount of money earned within those borders. This includes wages, rents, interest, and profits.

Within the income method, it is assumed that all economic expenditures should equal the income generated by the production of goods and services. It further expects that there are four major factors of production in an economy, with revenues going to one of these four factors.

The primary difference between the two approaches, then, and the easiest way to understand their distinction, is their starting points:

• The expenditure approach starts with money spent on goods and services; the income approach begins with income earned from the production of goods and services.
• Yet the expenditure approach remains the more common and practical method for calculating nominal GDP (and ultimately real GDP), while the income approach is generally considered to be more accurate. Economists often use both methods to produce one final estimate of GDP.

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