What is the Expenditure Approach?

The expenditure approach is a method for calculating gross domestic product (GDP) by adding up expenditures on goods and services. The logic behind this approach relies on the idea that people and companies make goods and things for sale, and therefore determining the volume of sales provides information about how much they made. This is only one way for determining GDP; another method is the income approach, where analysts look at income from labor, investments, and other activities.

There are four main categories in the expenditure approach. The first is consumption of products and services, ranging from washing machines to factory equipment. The second is investment, funds companies and individual use to buy inventory and fixed assets. Government spending is also a component, as are national exports. Each section can take up varying parts of the GDP, and part of the calculation process includes a determination of the largest areas of economic activity to learn more about a nation's economic health.

There are some flaws with the expenditure approach. One of the biggest problems is that it does not count goods and services produced for personal use. There is no way, for example, to add child-rearing to any of the four categories. Likewise, people who do things like growing their own food and producing goods like clothes to use at home are more difficult to track. This can have the effect of erasing some contributors to the economy. It can also create a problem when an economy transitions, and more of these goods and services come from outside the home. The GDP will grow, but changes in personal household activities will not be reflected in the GDP change.

The expenditure approach to GDP can be useful for providing general information about economic conditions and studying changes in GDP over time. Analysts may use several methods and compare them to see how accurate they are and to learn more about where the weaknesses in various methods lie so they can compensate for them. Generally, analysts want to see steady, dependable growth, but they are alert to tricks to manipulate GDP, like numbers that rise a little too consistently to be true each year; a nation saying it is growing by 10% annually, for example, may not be calculating its GDP very accurately.

One advantage to the expenditure approach is the ability to see how people and governments spend their money. Consumption is usually the largest category, while exports tend to be the smallest. Shifts in investment and government spending can reveal changing market conditions and social attitudes.