-->

Wednesday, January 26, 2011

GDP Explained: The Expenditure Approach

You must have come across the term GDP growth as a barometer for economic growth of a nation. In layman terms, the higher this rate, the better the economy is believed to be performing and vice-versa. But, what is GDP? Gross Domestic Product, or GDP, is defined as all final goods and services produced in an economy in a year, measured at market prices. Here, it is significant to note that this is a country-level measure and only the production within a nation’s political boundaries is taken into account.



As per the Expenditure Approach, GDP can be summed up in the form of a formula as:
GDP = Total Consumption + Total Investments + Government Expenditure + Net Exports

The components of the GDP calculation are explained below:

  • Consumption: All types of expenditure, except that for capital formation or investment, is included under this head. It is the total expenditure by all the consumers on the purchase of goods and services. Goods can be broadly divided into durable and non-durable goods. Popular examples of durable household goods are ‘white goods,’ such as washing machines, refrigerators, microwave ovens, and so on. Automobiles also fall in the same category, unless erected as specialized capital goods. Non-durable goods include perishable items, like fruits, vegetables, processed food items, cosmetics & other personal care products, apparels, footwear, stationery, rent, soaps & detergents, and the like. Services include the entire spectrum, right from professional & medical facilities to car wash & laundry services. Demand and the consequent consumption are among the most powerful drivers of an economy, as they provide the business incentive to produce more, thereby fueling growth through increased business activities and employment generation.
  • Investment: It is the sum total of all investments in capital goods and services, by the consumers and business enterprises. Any exchange of assets, such as purchase of shares or debentures, does not qualify. In short, savings are excluded. Capital goods are those goods that are not available for direct consumption, rather are used for producing goods (including capital goods) and services over a period of time. These include farming equipment, machinery, computers, etc. Businesses also invest in factories, office buildings, warehouses, guesthouses, and so on. All these outflows fall within the purview of business investments. New houses built are also included here. However, repurchase of pre-owned homes or those counted in any previous year are excluded. Changes in accumulated inventories are counted in the year of processing or production and not in the year of sale or use of such inventory. In growing economies, the investment leg forms an important part of GDP due to higher channelization of resources in infrastructure and industrialization.
  • Government Spending: Unlike what the name suggests, it includes both, expenditure and investments by the Government. Amounts spent on developing rails, roads, ports, salaries, purchases, and the like, form parts of government spending. On the other hand, redistribution of income for public welfare as aids, social security, financial support, etc. is counted out.
  • Net Exports: This component is the net of exports and imports in the country for the year under study. High net exports is a healthy sign, as it helps in driving business activity on the back of demand, over and above the domestic one, in earning valuable foreign exchange, and enhancing money supply.

Eurion Constellation is a research and consulting firm serving businesses in U.S., Europe and India. The research services have a global reach with focus on industry / market / economic research, financial analysis, equity research, company valuations and report writing. The consulting wing in India focuses on the startup and SME sectors. Please feel free to get in touch for any business requirements. Visit http://www.eurionconstellation.com

facebook.eurionconstellation.com | twitter.eurionconstellation.com

No comments:

Post a Comment