Expenditure Method

An alternative way to calculate the GDP is by looking at the demand side of the products. This method is referred to as the expenditure method. In the farmerbaker example that we have described before, the aggregate value of the output in the economy by expenditure method will be calculated in the following way. In this method we add the final expenditures that each firm makes. Final expenditure is that part of expenditure which is undertaken not for intermediate purposes. The Rs 50 worth of wheat which the bakers buy from the farmers counts as intermediate goods, hence it does not fall under the category of final expenditure. Therefore the aggregate value of output of the economy is Rs 200 (final expenditure received by the baker) + Rs 50 (final expenditure received by the farmer) = Rs 250 per year. Firm i can make the final expenditure on the following accounts (a) the final consumption expenditure on the goods and services produced by the firm. We shall denote this by Ci. We may note that mostly it is the households which undertake consumption expenditure. There may be exceptions when the firms buy consumables to treat their guests or for their employees (b) the final investment expenditure, Ii, incurred by other firms on the capital goods produced by firm i. Observe that unlike the expenditure on intermediate goods which is not included in the calculation of GDP, expenditure on investments is included. The reason is that investment goods remain with the firm, whereas intermediate goods are consumed in the process of production (c) the expenditure that the government makes on the final goods and services produced by firm i. We shall denote this by Gi. We may point out that the final expenditure incurred by the government includes both the consumption and investment expenditure (d) the export revenues that firm i earns by selling its goods and services abroad. This will be denoted by Xi . Thus the sum total of the revenues that the firm i earns is given by RVi ≡ Sum total of final consumption, investment, government and exports expenditures received by the firm I ≡ Ci + Ii + Gi + Xi

Let C be the aggregate final consumption expenditure of the entire economy. Notice that a part of C is spent on imports of consumption goods. Let Cm denote expenditure on the imports of consumption goods. Therefore C – Cm denotes that part of aggregate final consumption expenditure that is spent on the domestic firms. Similarly, let I – Im stand for that part of aggregate final investment expenditure that is spent on domestic firms, where I is the value of the aggregate final investment expenditure of the economy and out of this Im is spent on foreign investment goods. Similarly G – Gm stands for that part of aggregate final government expenditure that is spent on the domestic firms, where G is the aggregate expenditure of the government of the economy andGm is the part of G which is spent on imports