Expenditure Method of Measuring National Income

Expenditure Method of Measuring National Income –

Expenditure method gives the national income by adding up all the expenditures made on goods and services during a year.

Income can be spent on consumer goods or capital goods or on both. Expenditure can be made by private individuals and household or by the government and business firms.

People of the foreign countries spend on the goods and services which a country exports to them.

In the same way, people of a country spend on imports of goods and services from other countries.

We add up all the expenditures made by the government, household and firms or businesses to get the national income by expenditure method.

Types of expenditures included (added) in expenditure method to get the national income are –

1. Expenditure on consumer goods and services by individuals and households. This type of expenditure is called final private consumption expenditure and is denoted by C.

2. Government’s expenditure on goods and services to satisfy collective wants of the people/public or society. This type of expenditure is called government’s final consumption expenditure and is denoted by G.

3. The expenditure made by firms/businesses on capital goods and inventories/stocks. This type of expenditure is called gross domestic capital formation or gross domestic investment and is denoted by I or GDCF.

Gross Domestic Capital Formation is divided into two parts which are –

(a) Gross Fixed Capital Formation

(b) Addition to the Stocks/Inventories of Goods

4. Expenditure made by foreigners on goods and services of a country exported to other countries. We deduct the expenditure made by the people, government and businesses of a country on imports (M) from exports (X) to get the net exports (X – M).

We add up these four types of expenditure to get the final expenditure on gross domestic product at market prices (GDP_MP).

GDP_MP = Final Private Consumption Expenditure + Final Government Consumption Expenditure + Gross Domestic Capital Formation + Exports – Imports

GDP_MP = C + G + I + (X – M)

After subtracting depreciation (consumption of fixed capital) from Gross Domestic Product at Market Prices (GDP_MP) we get Net Domestic Product at Market Prices (NDP_MP).

When we subtract the Net Indirect Taxes (Indirect Taxes – Subsidies) from the NDP_MF we get Net Domestic Product at Factor Cost (NDP_FC).

When we add the Net Factor Income from Abroad in NDP_FC we get the Net National Product at Factor Cost (NNP_FC) which is also called National Income.

NNP_FC = GDP_MP – Depreciation – Net Indirect Taxes + Net Factor Income from Abroad

Government’s Final Consumption Expenditure on Goods and Services –

The general government provides services such as law and order, defense, education, health etc. to satisfy collective wants of its citizens/people. The government buys goods and services from others for providing its services to the people.

The cost of purchased goods and services by the government to provide its services to the people to satisfy collective wants is called Intermediate Consumption. The government also employs persons in various departments and pays them wages and salaries.

Government’s final consumption expenditure on goods and services includes –

(1) Compensation to employees

(2) Intermediate consumption expenditure by the General Government (which means purchases of goods and services by the Government less sales of some goods by it.)

(3) Consumption of fixed capital

Transfer Payments by the Government –

Government spends a lot on making transfer payments which is not included in gross national product. Some examples of transfer payments are social security benefits, old age pensions, unemployment allowance etc.

These transfer payments are not included in national income because they are not paid in exchange for the contribution to the current production of goods or rendering services by the recipients to the government in the current year.

In making transfer payments the government just transfers a part of its revenue to specific individuals without any contribution by them to the current production of goods and services.

If these are added to the national income it would overestimate current year’s production.

Precautions –

1. Second-hand goods –

The expenditure made on second-hand goods should not be included because these goods are previously produces and included.

2. Purchase of shares and bonds –

Expenditure on purchase of old shares and bonds from other people and from business firms should not be included.

3. Expenditure on transfer payments by the government –

Expenditure on transfer payments by the government such as old age pension, social security benefits, unemployment benefits should also not be included. Because they are not paid in exchange for the contribution to the current production of goods or services by the recipients to the government in the current year.

4. Expenditure on intermediate goods –

Intermediate goods are used to produce final goods which are used by everyone. So, expenditure on intermediate goods should not be included because it will create problem of double counting. Therefore to estimate the Gross Domestic Product we have to include only expenditure on final goods and services.