Measuring GDP by the expenditure approach leads us to the final buyers of all U.S. output.

Aggregate Expenditures are the sum of (a) consumer spending, (b) business investment, (c) government purchases, and (d) net spending by foreigners.

This summation echoes the sources of Aggregate Demand described in a previous chapter. Figure 2 shows the division of the national pie into consumption (C), investment (I), government purchases (G), and net exports, i.e., exports - imports (X - M).[1]

Personal Consumption Expenditures (C)

Household outlays include spending on nondurable goods (food and clothing), durable goods (appliances and cars), and services (e.g., medical care or haircuts).

Personal consumption expenditures (C) are the values of all commodities and services that households and individuals buy.

This category is familiar because we all engage in consumption every day.

Business Investment (I)

Remember that investment, as economists use the term, does not refer to the flows of money or documents that we term financial investment.

Economic investment refers to acquisition of new physical capital.

Business spending for new capital is called Gross Private Domestic Investment, or GPDI. Gross means that all purchases of new buildings, equipment, and the like are included. Whether investment replaces obsolete or worn-out capital does not matter. Private means that government investment is excluded. Domestic means that the new capital is bought from U.S. producers. We exclude foreign investments by American firms, but investment by foreign companies in the United States is part of our GPDI.

 

            The major components of investment spending are

1.         All new construction, including housing.

2.         All final purchases of new equipment (e.g., machinery and tools).

3.         Changes in business inventories.

 

            New production facilities, apartment buildings, and office space clearly fit the definition of investment, but why not treat residential construction as consumer spending? Consequently, housing is regarded as a capital good, and all new construction is included in investment. On the other hand, the rental value of owner-occupied housing is considered consumption— a home produces shelter year after year.

 

            The second item, capital equipment, expands the productive capacity of firms and thus, is clearly investment. But what about stocks and bonds? Securities are financial rather than economic investments. Purchases of new stocks and bonds may facilitate business spending on real capital, but security transactions merely transfer purchasing power from buyers of stock to sellers without directly boosting productive capacity. Thus, purely financial transactions are not economic investment.

 

            Inventory growth is also investment, while declines are disinvestment. Business inventories include (a) raw materials or intermediate goods bought for use as productive inputs and (b) finished goods held in stock to meet customers' demands. Customers quickly switch to other firms if your firm fails to deliver promptly. Adjustments for inventory changes are needed because we use sales data to estimate production. If inventory growth were ignored, GDP would understate total production. Inventory growth adds to investment, while shrinkage reduces investment. Goods held in business inventories should be counted in GDP in the year produced—not the year sold. Inventories vary from year to year, so changes in inventories must be estimated to consistently measure total production and our national income.

Government Purchases (G)

            We consume commodities and services both as private individuals and collectively, through government. Government may buy goods in finished form from private firms, or it may pay for intermediate (unfinished) goods or basic resources to produce the final goods and services it provides. The most important resource government buys is its employees' labor.

 

            Government purchases of goods and services (G), ranging from pay for police officers to fire hydrants to cancer research, are then provided at zero or minimal prices to their users. Many goods and services that government purchases and then provides are not sold in markets, so their value cannot be known with precision. Thus, all government goods enter the GDP accounts at the prices government pays for them—for GDP accounting purposes, government is assumed to add nothing to the value of the labor and other resources it uses.

 

            Note that government purchases do not include transfer payments, (e.g., Social Security or federal payments for disaster relief) that merely shift funds from one set of households to another set. Because transfers payments do not require production, they affect consumption and, consequently, Aggregate Demand only when recipients spend the funds received from government.

 

Net Exports (X - M)

 

Net exports are defined as exports (X) minus imports (M).

Exports are goods manufactured domestically and bought by foreigners.

We clearly must include exports in GDP to measure the value of all production in a year. But do imports reflect American production? The obvious answer is "No."

Imports are goods produced in foreign countries and consumed or invested in the United States.

            A Hyundai purchased in the United States is part of Korean production (and adds to Korean consumption when the owners of resources that produce the car spend their pay). When Americans buy a Hyundai, the price paid to Korean producers must be subtracted from U.S. consumption or it will appear that the car was produced in the United States. Similarly, if Swiss machinery is installed in an American factory, the purchase appears in the U.S. investment category, but it  should be subtracted from U.S. GDP. Thus, in the expenditures approach to calculating GDP, imports are subtracted from exports to estimate the net effect of foreign trade on our economy.

 

            To summarize: Using the expenditure approach, Gross Domestic Product is the sum of consumer spending (C), business investment (I), government spending for goods and services (G), and net exports (X - M):

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

Table 1 shows these expenditures.

 

Table 1   Gross Domestic Product: The Expenditure Approach
Component	Billions of 1993 dollars
Personal Consumption Expenditures                 (C)	$  4,418.2
Gross Private Domestic Investment                     (I)	882.5
Government Purchases of Goods and Services     (G)	1,160.8
* Net Exports of Goods and Services                  (X - M)	- 65.2
Gross Domestic Product	$   6,396.3
* This negative number reflects a deficit in the 1993 U.S. balance of trade. Since 1982,     we have consistently imported more than we exported since 1982. Note: Rounding may              cause minor inconsistencies.              Source: Economic Report of the President, 1994.

 

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