Introduction
Measuring GDP
There are three methods of measuring the GDP - the income method, production method and expenditure method. The three methods come from the concept of GDP. The production of goods and services creates income for the factors involved in the production process. The laborers receive wages and salaries, the entrepreneur receives profit, the investor earns interest and the property owner receives rent. If we take the sum of the income of the factors involved in the production process we get the GDP. This is the income method. In the production method we take the value of total product of the goods and services produced in the economy. In the expenditure method we view the GDP from the expenditure side that is, the expenditure made on the goods and services produced in the economy. This also adds up to the value of total production. Let us discuss the components of GDP using the expenditure method.
The Four Components of GDP
The four components of GDP are :
Consumption ( C)
Investment (I)
Government Expenditure (G)
Net Exports (NX)
GDP is the sum of these four components. We can write the GDP (Y) as:
Y = C + I + G + NX
Let us now discuss each component separately.
Consumption
The expenditure on goods and services by the households come under consumption expenditure . Consumption expenditure can be categorized into durables, non durables and services. Goods like car, TV, washing machines are durable goods. Food items, cosmetics etc. are non durable goods, that last for a short period of time. When we go to the salon to get a facial or hair cut this is a service. Increase in the income increases consumption expenditure. Higher consumption expenditure raises the aggregate demand and the price level leading to higher production that increases the GDP.
Investment: Investment refers to the goods or services that are purchased for use in production in the future. The expenditure on plants and machineries by the firms are included here. Expenditure on buildings also comes under this category. Inventory accumulation for future sales also can be viewed as investment expenditure . Higher investment means higher future stream of production in the economy.
Government Expenditure: The goods and services purchased by the government come under this category. Purchase of defense equipments, building of roads and bridges, payment to the government staff, all these are included in this category. Increase in government expenditure leads to higher income for the individuals directly involved with the government. The resultant increase in the aggregate demand increases the GDP.
Net exports: This is the value of goods and services exported minus the value of goods and services imported. If exports are higher than imports this component has a positive value. The country earns net income from abroad. If imports are higher than exports this has a negative value implying that we are paying more for foreign goods than on domestically produced goods.
Conclusion
In this paper we discussed the concept of GDP and the components of GDP in the expenditure side. We can see that GDP can be viewed from three different angles and expenditure is one of them. The analysis shows how each component of the GDP affects the economy.
References
Banerjee, A., & Mazumdar, D. (2010). Principles of Economics. Kolkata: ABS Publishing House.
Branson, W. H. (1989). Macroeconomic Theory and Policy. McGraw Hill.
Mankiw, G. (2013). Macroeconomics. Macmillan.
