EXPENDITURE METHOD

EXPENDITURE METHOD

This method measures national income as the sum total of final expenditure incurred by households, business firms, governments, and foreigners.

This method is also known as ‘Income Disposable Method’.

Components of Final Expenditure:

1. Private final consumption expenditure-

As the name suggests, it is the expenditure made by households and private non –profit sharing institutions on all type of consumer goods.

 It includes the following:

• Household final consumption expenditure.
• Private non-profit institutions serving household final consumption expenditure.
• Expenditure made by normal residents abroad during any tour and travel.

However, any expenditure made by foreign tourists in the domestic market would be deducted.

2. Government Final Consumption Expenditure- 

It refers to expenditure made by the government on various administrative services like defence, law, and order, education, etc.

It includes the following:

• Intermediate consumption by government.
• Compensation paid by the government.
• Direct purchase from abroad for embassies and consulates located abroad.

However, it does not include the sale of goods and services produced by the general government.

3. Gross Domestic Capital Formation or Gross Investment-

Definition: It refers to the addition to the capital stock of the economy.

Following are components of GDCF:

• Gross fixed capital formation: it refers to expenditure made on purchase to a fixed asset. It includes the following Gross business fixed investment - (expenditure on new plants, machinery, equipment, etc). 

• Gross Residential construction investment- (it includes expenditure on purchase of new houses by households). 

• Gross public investment – (expenditure on construction of flyovers, bridges, etc by the government).

• Inventory Investment – it refers to the amount by which the firm’s inventories change during a period. it may include stock of raw material, semi-finished goods lying with producers.

It is calculated as the difference between closing stock and opening stock of the year.

• Change in Inventories = closing stock - opening stock.
• GDCF = Gross Fixed Capital Formation+ inventory Investment.

4. Net Exports:

It refers to the difference between exports and imports of a country, during a period of one year. Instead of taking Imports and exports separately, the difference between the two is taken as it is turned as Net Exports.

Net Exports=Export – Import

Steps in Calculating Net Exports

Following steps are involved in the calculation of national income by expenditure method:

Step-1 Identify the economic units incurring final expenditure-

All economic units, which incur final expenditure within the domestic territory, are classified under four groups:

• Households sector   
• Govt. Sector
• Producing sector    
• Rest of the world sector

Step-2 Classification of Final Expenditure –

Final expenditure by above economic units are estimated and classified under the following heads:

• Private Final Consumption Expenditure (PFCE)
• Government Final Consumption Expenditure (GFCE)
• Gross Domestic Capital Formation (GDCF)
• Net Exports (X-M)

Sum of all of the above components gives GDP.

GDP at MP = PFCE + GFCE + GDCF + (X-M)

Step-3 Calculate Domestic Income (NDPFC)-

Now to calculate NDP at FC from GDP at MP, we need to subtract depreciation and Net Indirect Taxes (NIT).

Step-4. Estimate net factor income from abroad to arrive at national income.

Finally, we add net factor income from abroad to NDPFC in order to get NNPFC (National Income).

Precautions of Expenditure Method

Expenditure on intermediate goods will not be included in national income: As intermediate goods are already included in the value of final expenditure, and if it is included again it will lead to double counting.

Transfer Payments are not included: As these payments are not connected with any productive activity, these are not added while calculating national income.

Purchase of second-hand goods will not be included: As the sale of second - hand goods are already included at the time when they were originally purchased. However, any brokerage or commission on such goods is included as it is the payment made for productive service.

Purchase of financial assets: Transactions relating shares, debentures, bonds etc. are not included, as they do not contribute to the current flow of goods and services. (Commission, brokerage on such transaction to be included)

Expenditure on own account production: Production for self - consumption, imputed value of owner occupied house, free services from general government and private non-profit institutions serving households will be included in national income since these are productive services.