Gross Domestic Product (GDP) is generally thought of as a measure of an economy's aggregate output or income, but, as it turns out, GDP also represents aggregate expenditure on an economy's goods and services. Economists divide the spending on an economy's goods and services into four components: Consumption, Investment, Government Purchases, and Net Exports.
Consumption (C)
Consumption, represented by the letter C, is the amount that households (i.e. not businesses or the government) spend on new goods and services. The one exception to this rule is housing since expenditure on new housing is placed in the investment category. This category counts all consumption spending regardless of whether the spending is on domestic or foreign goods and services, and the consumption of foreign goods is corrected for in the net exports category.
Investment (I)
Investment, represented by the letter I, is the amount that households and businesses spend on items that are used to make more goods and services. The most common form of investment is in capital equipment for businesses, but it's important to remember that households' purchases of new housing also counts as investment for GDP purposes. Like consumption, investment expenditure can be used to purchase capital and other items from either domestic or foreign producer, and this is corrected for in the net exports category.
Inventory is another common investment category for businesses since items that are produced but not sold in a given time period are considered as having been purchased by the company that made them. Therefore, the accumulation of inventory is considered positive investment, and the liquidation of existing inventory is counted as negative investment.
Government Purchases (G)
In addition to households and businesses, the government can also consume goods and services and invest in capital and other items. These government purchases are represented by the letter G in the expenditure calculation. It's important to keep in mind that only government spending that goes towards producing goods and services is counted in this category, and "transfer payments" such as welfare and social security are not counted as government purchases for the purposes of GDP, mainly because transfer payments do not directly correspond to any type of production.
Net Exports (NX)
Net Exports, represented by NX, is simply equal to the amount of exports in an economy (X) minus the number of imports in that economy (IM), where exports are goods and services produced domestically but sold to foreigners and imports are goods and services produced by foreigners but purchased domestically. In other words, NX = X - IM.
Net exports is an important component of GDP for two reasons. First, items that are produced domestically and sold to foreigners should be counted in GDP, since these exports represent domestic production. Second, imports should be subtracted out from GDP since they represent foreign rather than domestic production but were allowed to sneak into the consumption, investment and government purchases categories.
Putting the expenditure components together yields one of the most well-known macroeconomic identities:
In this equation, Y represents real GDP (i.e. domestic output, income, or expenditure on domestic goods and services) and the items on the right-hand side of the equation represent the components of expenditure listed above. In the US, consumption tends to be the largest component of GDP by far, followed by government purchases and then investment. Net exports tend to be negative becausethe US typically imports more than it exports.
FAQs
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.
What are the four expenditure categories of GDP? ›
Economists divide the spending on an economy's goods and services into four components: Consumption, Investment, Government Purchases, and Net Exports.
What expenditures are included in GDP? ›
Calculating GDP using the expenditure approach accounts for the sum of all final goods and services purchased in an economy over a set period. Expenditures include consumer spending, government spending, business investment spending, and net exports.
What is the expenditure on the gross domestic product? ›
Expenditure on GDP is the total value of spending on goods and services produced within the borders of a country. It excludes imports since imports are produced in the rest of the world, but includes exports since exports are produced within the borders of the country. In symbols it is written as C + I + G + (X – Z).
What are the categories of GDP? ›
There are four main components of GDP; consumption, investment, government spending, and exports. Consumption is the largest component of GDP and is a measure of all spending by households on goods and services.
What are the 4 components of expenditure? ›
The expenditure approach uses four critical types of spending: consumption, investment, net exports of goods and services, and government purchases of goods and services to calculate gross domestic product (GDP).
What are the 4 categories used to calculate the GDP? ›
The four components of gross domestic product are personal consumption, business investment, government spending, and net exports.
What 4 groups of spending are included in GDP? ›
The Expenditure Approach divides GDP based on who is doing the spending: Consumption (households), Investment (businesses and households), Government Spending (governments) and Net Exports (the rest of the world). GDP can also be measured by examining what is produced, instead of what is demanded.
What are the four major components of expenditures in GDP Part 4? ›
The four major expenditure components of GDP are Consumption(C), Investment(I), Government Spending(G), and Net Exports(NX). They are represented in the GDP equation as: G D P = C + I + G + N X .
What is not included in GDP expenditure? ›
There are several things that GDP does not include such as activity between businesses, sales of goods or services produced outside the country, illegal goods or services, intermediate goods, transfer payments, and used goods.
The second impact of housing on GDP is the measure of housing services, which includes gross rents (including utilities) paid by renters, and owners' imputed rent (an estimate of how much it would cost to rent owner-occupied units) and utility payments.
Is household expenditure included in GDP? ›
Household spending including government transfers is measured as a percentage of GDP. Spending in housing is presented as a percentage of household disposable income.
What is the gross domestic product expenditure method? ›
What is the Expenditure Method? The expenditure method is a gross domestic product (GDP) measurement scheme, which incorporates consumption, production, government spending, and net exports. It is the most commonly used way of estimating GDP.
What are the three expenditure categories of GDP? ›
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.
What 4 things are not included in GDP? ›
What is not included in GDP?
- Intermediate goods that have been turned into final goods and services (e.g. tires on a new truck)
- Used goods.
- Transfer payments.
- Non-market activities.
- Illegal goods.
GDP is composed of goods and services produced for sale in the market and also includes some nonmarket production, such as defense or education services provided by the government.
What are the 4 expenditure approaches? ›
The expenditure approach to calculating GDP is equal to the sum of consumer spending (C), government spending (G), business investments (I), and net exports (X-M). It is calculated the same as aggregate demand within an economy.
What are the four major areas of expenditure? ›
These four categories—national defense, Social Security, healthcare, and interest payments—account for roughly 71% of all federal spending, as Figure 2 shows.
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