Useful Notes on Components of GDP in Expenditure Phase | Micro Economics

Final expenditure consists of consumption expenditure and investment expenditure. These are its two main components. They are further classified keeping in view the spending categories as shown below:

Final expenditure on GDP = Private final consumption expenditure + Government final consumption expenditure + Gross fixed capital formation + change in stocks + net exports

1. Private final consumption expenditure:

It measures the money value of goods and services purchased by households and non-profit institutions for current use during a time period. In this category, we include consumption expenditure by consumer households and private non-profit institutions serving households on all types of consumer goods (i.e., durable, semi-durable, non-durable goods and services).

Again it may be noted that direct purchases made abroad by resident households are added but direct purchases in domestic market by non-resident households (foreigners) and extra-territorial bodies are deducted. However net sales of second-hand goods and scraps should be deducted.

2. Government final consumption expenditure:

It is defined as “Current expenditure on goods and services incurred in providing services of government administrative departments less sales.” It is incurred by government to satisfy collective needs of the people. For example, government expenditure on health, education, general administration, law and order, etc. belongs to this category.

Government final consumption expenditure consists of the value of following items:

(i) Net purchases of currently produced goods and services in the domestic market which is obtained by multiplying the volume of sales to government by the enterprises with the retail prices;

(ii) Compensation of employees paid by the government and

(iii) Direct purchases/room abroad by the government less value of sales.

Sum of these items gives us the figure of government final consumption expenditure.

3. Gross fixed capital formation:

This refers to increase in stock of fixed capital during a year which includes depreciation.

It includes expenditure on following three items:

(i) Business fixed investment:

This is defined as addition to machinery, factory building and equipment.

(ii) Residential construction investment:

This refers to addition of housing facilities.

(iii) Public investment:

This refers to capital formation by government in the form of schools, hospitals, roads, canals, etc.

4. Change in stocks:

This refers to the physical change in stocks of inventories like raw material, semi-finished goods and finished goods lying with the producers for smooth working of production process. Change in stocks is measured by subtracting opening stock from closing stock. Alternatively it is the difference between the stocks in the beginning and in the end of the year.

Expenditure on it is found out by multiplying the physical change in stocks (lying with the producers) with the market prices. It should be noted that the value of change in stock of goods lying with consumers should not be included because all consumer goods are deemed as consumed the moment they are purchased by the consumers.

Note: Sum of gross fixed capital formation (item 3) and change in stock (item 4) is called Gross domestic capital formation.

5. Net exports:

(Exports less imports). This refers to the difference between value of exports (e.g., expenditure by foreigners on direct purchase of Indian products) and value of imports (i.e., expenditure by Indians on direct purchase of foreign goods).

Be it noted that from expenditure point of view, value of exports is added and that of imports is deducted. To illustrate, suppose India manufactures cycles worth Rs 100 crore and thereby generates income of the same value in a given year.

Further suppose, India consumes cycles worth Rs 80 crore and exports the balance stock of cycles worth Rs 20 crore to UK. In this case, India’s final expenditure is 80 crore against generated income of 100 crore. But if we add expenditure on Indian cycles by UK also, India’s final expenditure (Rs 80 + Rs 20 crore) will be equal to the value of domestic product (Rs 100 crore).

Thus, exports, being a part of domestic product, expenditure on it by foreigners should be added and value of imports should be deducted. In short, domestic expenditure which is equal to domestic product is not the expenditure by the normal residents but expenditure on domestic product (by residents and foreigners).

Similarly, value of imports should be deducted because they increase domestic expenditure and not domestic product (income); otherwise, domestic product from the viewpoint of expenditure will be larger than domestic product calculated by production or Income methods.

Hence, from expenditure point of view, value of exports should be added and that of imports should be deducted. In this way, net exports (exports – imports) form a part of expenditure on gross domestic product. Remember, when value of imports is greater than that of exports, it is called net imports. Again, exports are treated as investment in foreign country by the exporting country and imports as disinvestment. Thus, net exports (exports less imports) indicate net investment abroad.

Is export apart of domestic product? Yes, because all the goods and services which are exported are produced by the producers in the domestic economy For instance, Indian tea, coffee jute goods, etc., which are purchased by foreigners, are produced in India and it is called India’s export.

In short, since exported goods and services are produced m domestic territory of a country, therefore, export of goods and services is a part of gross domestic product (GDP). Beware, export receipts are not ‘net factor income from abroad’ as they are revenue of the firms from sale of their products.

Note: By adding the above-mentioned five components, we get Gross Domestic Product at Market Price (GDP_FC) in its expenditure phase. If we subtract from it depreciation and net indirect taxes, we get Net Domestic Product at Factor Cost (NDP_FC) domestic income. By adding to its net factor income from abroad, we get NNP_FC or national income.