2.2.2. Expenditure Method

An alternative way to calculate the GDP is by looking at the demand side of the products. This method is referred to as the expenditure method.

The expenditure method is one of the ways to calculate the Gross Domestic Product (GDP) of a country. Instead of focusing on what is produced, it looks at how much is spent on final goods and services. This method considers all the expenditures made in the economy, which includes consumer spending, business investments, government expenditures, and net exports (exports minus imports).

Think of an economy as a large shopping mall where every purchase contributes to the total sales. Just like each customer's expenditure adds up to the total revenue of the mall, in an economy, all final expenditures contribute to the overall GDP.

In the farmer-baker example that we have described before, the aggregate value of the output in the economy by expenditure method will be calculated in the following way. In this method we add the final expenditures that each firm makes.

To calculate GDP using the expenditure method, we begin with the final expenditures. Final expenditure refers to money spent on goods and services for their ultimate use, excluding spending on intermediate goods used in production. In the farmer-baker scenario, the baker's purchase of wheat is treated as an intermediate good, so it doesn't count towards the final GDP. However, the money spent by consumers on bread, which is a final product, will count towards GDP.

Imagine you are at a restaurant. The money you pay for a meal is part of the restaurant's final income. However, if you were to buy ingredients to cook at home, the spending on those ingredients wouldn’t contribute to the restaurant's sales – it would only contribute to the sales of the grocery store.

Firm i can make the final expenditure on the following accounts (a) final consumption expenditure, (b) final investment expenditure, (c) government expenditure, and (d) export revenues.

When calculating GDP through the expenditure method, we consider different types of expenditures that firms earn from: 1. Consumption expenditure (C) which is mostly done by households for goods and services they buy. 2. Investment expenditure (I) which businesses make to purchase capital goods from other firms. 3. Government expenditure (G) which includes spending by the government on various services. 4. Export revenues (X), which are the incomes firms earn from selling goods and services to foreign consumers.

Consider a bakery. The money it earns from selling pastries (C) is just one source of income. If the bakery invests in new ovens (I), receives funding from the government for local businesses (G), and sells some pastries to a local café (X), all of these sources contribute to its overall financial health and are included in the GDP calculation.

The sum total of the revenues that the firm i earns is given by RV ≡ C + I + G + X.

The total revenue (RV) for a firm from the expenditure perspective is simply the sum of all types of spending that the firm receives, including consumption, investment, government payments, and exports. This total revenue represents the firm's contribution to the economy's GDP.

Think of RV like the total earnings of a concert. Ticket sales (C), sponsorship from local businesses (I), grants from the government (G), and merchandise sales to fans from outside the town (X) all add up to the concert's total revenue. Similar to this concert, all these different types of spending collectively form the GDP.

Thus, GDP ≡ ∑N RV ≡ C + I + G + X − M.

The GDP can be calculated by summing the total revenues from all firms in the economy, expressed as RV for each firm added together. The equation also takes imports (M) into account because expenditures on these do not contribute to domestic production. The final format of the equation shows how to arrive at the GDP by including three components: consumption, investment, and government spending, and adjusting for net exports.

Imagine a school year where students earn points from different activities like attending class (C), projects (I), and participating in school events funded by the government (G). However, points lost from regular absences (M) lower the final score, just as imports lower the GDP.

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