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Expenditure Method of Measuring National Income

In the expenditure method, national income is estimated by adding up the expenditure incurred on the purchase of final goods and services by the various sectors of the economy in an accounting year. The main expenditure done in an economy is either on consumption or investment. Hence, the expenditure done in an economy is divided into consumption expenditure and investment expenditure. 

The sectors of the economy which incur expenditure are the households, firms, government and external sector and their respective expenditures are Consumption expenditure, Investment expenditure, Government expenditure and expenditure on exports and imports.

GDP = C + I + G + (X-M)

The income generated in the economy falls into one of these four categories.This equation also represents an identity as the equation always holds because the variables are defined in such a way. Lets study each component individually

1. Consumption Expenditure (C)

Includes the expenditure done by households on the purchase of final goods and services. Goods are can be durable (which last for a long period of time such as cars, refrigerators etc) or non-durable (which last for a short period of time like milk, fruits etc). Services include various intangible services like teaching, I.T, banking etc). The consumption expenditure of private non-profit institutions is also included. Consumption expenditure is also known as private final consumption expenditure. Expenditure on construction of houses or residential property is not included in consumption, it is included in investment.

2. Investment Expenditure (I): 

It includes expenditure on such goods which help in the production of more goods and services or which are helpful in adding to the productive capacity of the nation. 

Investment can be broadly of two types 

1)Fixed Investment and,

2)Inventory Investment. 

Fixed investment refers to investment on fixed assets like equipment, plant and machinery It can be further classified into 

a)Business Fixed Investment, 

b)Residential Fixed Investment or Fixed Investment by households on construction of houses. 

In addition fixed investment is also done by the government in terms of expenditure on building roads, highways, dams etc. 

Inventory investment refers to the stock of firms good which are not sold.

3. Government Expenditure (G)

Apart from households even government has to incur expenditure on the purchase of goods and services for its functioning. These can be expenditure on defense equipment’s, purchase of office supplies, expenditure on services of government employees. Transfer payments such as scholarships, unemployment allowance are not included in this expenditure as these transfer payments are not done in exchange of/ accompanied by the production of goods and services.

4. Net Exports (X (exports)-M(imports)):

Nations trade goods and service among themselves. Goods and Services which are sold to other nations are called exports whereas goods and service bought from other nations form imports. Exports lead to earning of money and imports mean losing of money. The net of exports are included in the estimation on national income. Net exports refer to the value of exports minus the value of imports. Negative and positive.

The sum of these four expenditures gives us the total expenditure in an economy in a given year which is equal to GDPMP

GDPMP = Private Final Consumption Expenditure + Business Fixed Investment + Residential Fixed Investment by Households + Government Fixed Investment + Government Final Consumption Expenditure + Net Exports (Exports - Imports)

The NNPFC can then be derived by subtracting depreciation and adding Net Factor Income from Abroad 

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