Methods of GDP Calculation: Income, Expenditure & Product Method

• The expenditure method calculates GDP by adding all expenditure made on final goods and services produced within the economy.
• In this method, GDP is measured from the demand side.
• The basic idea is that whatever is produced in an economy is ultimately purchased by some sector. Therefore, GDP can also be measured by adding the expenditure made by different sectors on domestically produced final goods and services.
• There are four major spending sectors in the economy:
  • Household sector
  • Private business sector
  • Government sector
  • External sector

Expenditure by Different Sectors:

• Household Sector
  • The household sector mainly spends on consumption goods and services.This includes expenditure on food, clothing, education, healthcare, transport, housing, electricity, mobile services and other consumer items.This expenditure is denoted by C’, which stands for private consumption expenditure.

• Private Sector
  • The private business sector mainly spends on capital goods.This includes expenditure on machines, factories, tools, equipment, office buildings, technology and inventories.
  • This is called investment expenditure and is denoted by I’.

• Government Sector
  • The government spends on both consumption goods and capital goods.
  • For example, government expenditure may include salaries of government employees, defence services, public administration, schools, hospitals, roads, bridges, railways and other infrastructure.
  • This is denoted by G’.

• External Sector
  • The External Sector purchases both consumption and capital goods from our  economy. 
  • Exports are denoted by X.

Derivation of GDP Formula:

Household Sector

• C = Total consumption expenditure by households on both domestic and imported consumption goods.
• Cm = Imported consumption goods
• So, household expenditure on domestically produced consumption goods will be:
  • C′ = C – Cm

Private Sector

• I = Total investment expenditure by private sector on domestic and imported capital goods
•  Im = Imported capital goods
• So, private investment expenditure on domestically produced capital goods will be:
  • I′ = I – Im

Government Sector

• G = Total government expenditure on domestic and imported goods
• Gm = Imported goods purchased by government
• So, government expenditure on domestically produced goods will be:
  • G′ = G – Gm

GDP = C′ + I′ + G′ + X

Here, C′, I′ and G′ represent expenditure on domestically produced final goods and services.

Now substitute the values of C′, I′ and G′:

GDP = (C – Cm) + (I – Im) + (G – Gm) + X

GDP = C + I + G + X – (Cm + Im + Gm)

• Here, Cm + Im + Gm = Total Imports = M

Therefore, GDP = C + I + G + X – M

GDP can also be written as:

GDP = Private Consumption + Private Investment + Government Expenditure + Exports – Imports ,or 

GDP = Total Consumption + Total Investment + Exports – Imports

• Total Consumption = Private Consumption + Government Consumption
• Total Investment = Private Investment + Government Investment