Expenditure Approach for Measuring GDP: Videos & Practice Problems

The expenditure approach to calculating GDP sums up all spending on final goods and services within a country during a year. It includes four main components: Consumption (C), Investment (I), Government Purchases (G), and Net Exports (NX). Consumption covers household spending on goods and services, excluding new residential construction. Investment includes business spending on equipment, structures, inventory, and new residential construction. Government Purchases represent spending by local, state, and federal governments on goods and services, excluding transfer payments like welfare. Net Exports are calculated as exports minus imports, where exports are goods produced domestically and sold abroad, and imports are goods produced abroad and sold domestically. The GDP formula using the expenditure approach is: $\mathrm{GDP}=C+I+G+\mathrm{NX}$.

Financial investments such as stocks and bonds are excluded from GDP because GDP measures the value of final goods and services produced within a country during a specific period. Stocks and bonds represent financial transactions or transfers of ownership of existing assets rather than production of new goods or services. Including them would count money moving between owners rather than actual economic output. GDP focuses on production, so only spending on goods and services that contribute to current economic activity is included. This is why business investments in equipment, structures, and inventory are counted, but financial investments are not.

Nominal GDP measures the value of all final goods and services produced in a country using current prices during the year of production. Real GDP adjusts for inflation by using prices from a base year, allowing comparison of economic output across different years without the distortion of price changes. This means real GDP reflects the actual quantity of goods and services produced, while nominal GDP can be affected by changes in price levels. Real GDP is useful for analyzing economic growth and living standards over time.

GDP includes only final goods and services to avoid double counting. Intermediate goods are products used as inputs in the production of final goods. If intermediate goods were included, their value would be counted multiple times—once when sold as an intermediate good and again when included in the final product's price. For example, steel used to make a car is an intermediate good, while the car itself is the final good. Counting only final goods ensures GDP accurately reflects the total value of production within the economy during a specific period.

Government transfer payments, such as welfare or social security, are not included in GDP because they do not correspond to the production of new goods or services. These payments are simply transfers of money from the government to individuals. However, when recipients spend this money on goods and services, that spending is counted under consumption in GDP. Therefore, transfer payments indirectly affect GDP through the consumption they enable, but the payments themselves are excluded from government purchases in GDP calculations.