What is the Expenditure Method?
Expenditure method is a method used for the calculation of Gross Domestic Product (GDP) which combines consumption, production, net exports and government spending. This method focuses on aggregating the total expenditure made on final goods and services within an economy during a specific period, typically a year. It provides a comprehensive view of the economic activity by summing up all the spending in the economy.
Through this method, nominal GDP is calculated, which is further adjusted for inflation to find out the real GDP. Expenditure method and income approach are used to calculate GDP, the two contrast each other.
Expenditure Method: Formula & Working
Formula: GDP= C + I + G + (X- M), where:
- C: Consumption expenditure by households on goods and services
- I: Investors spending on capital goods that will be used to produce future goods and services.
- G: All government expenditures on goods and services.
- X: Exports from the country.
- M: Imports in the country.
The expenditure method calculates GDP by adding up all spending on final goods and services in an economy. This method is directly related to aggregate demand, which represents the total demand for goods and services at current prices. In the short term, GDP and aggregate demand generally move together because they both reflect total spending. However, over the long term, they align only when adjusted for changes in price levels. This adjustment is crucial as nominal prices can fluctuate, impacting the relationship between aggregate demand and GDP. Hence, while the expenditure method provides a snapshot of economic activity, understanding long-term trends requires considering inflation or deflation.
