7.2 The Expenditures Approach

What is the formula for GDP using the expenditures approach?

A: GDP = C + Ig + G + Xn
Where:

• C = Personal consumption expenditures

• Ig = Gross private domestic investment

• G = Government purchases

• Xn = Net exports (exports − imports)

What does Personal Consumption Expenditures include?

All household spending on final goods and services.

What are the three categories of personal consumption?

• Durable goods (10%) – e.g., cars, furniture

• Nondurable goods (30%) – e.g., food, clothing

• Services (60%) – e.g., healthcare, legal services

Why is the U.S. called a service economy?

Because 60% of personal consumption expenditures are for services.

What does “Gross Private Domestic Investment” include?

• Final purchases of machinery, equipment, tools

• Residential construction

• R&D and creation of intellectual capital (e.g., software, art)

• Changes in inventories

Why are inventory changes counted in GDP?

They represent output produced but not yet sold—still part of current production.

What happens when inventories increase?

It’s counted as positive investment (more output than consumed).

What happens when inventories decrease?

It’s counted as negative investment (selling past output, not current).

What’s the difference between economic and financial investment?

• Economic investment creates new capital (tools or recipes) → included in GDP

• Financial investment transfers ownership (stocks, bonds) → excluded from GDP

What is net investment?

Net investment = Gross investment − Depreciation

What does positive net investment mean?

Capital stock is growing → economy’s productive capacity expands.

What does negative net investment mean?

Capital stock is shrinking → economy is disinvesting.

Which investment measure is used in GDP?

Gross investment (Ig)

What does “Government Purchases” include in GDP?

1. Government spending on goods/services

2. Public capital (e.g., roads, schools)

3. R&D and knowledge-building

What does “Government Spending” exclude?

Transfer payments (e.g., Social Security, welfare) — not tied to current production.

What is the formula for net exports?

Xn = Exports (X) − Imports (M)

Why are exports included in GDP?

They reflect spending on goods produced within U.S. borders.

Why are imports subtracted in GDP?

Because C, Ig, and G may include foreign goods — subtracting M corrects for that.

What does a negative Xn mean?

The country imported more than it exported (trade deficit).

What are the three types of personal consumption?

• Durable goods – long-lasting (cars, furniture, appliances)

• Nondurable goods – short-lived (gas, food, clothing)

• Services – consumed immediately (haircuts, healthcare)

Why are durable and nondurable goods separated in GDP analysis?

They respond differently during recessions — durable goods drop more sharply.

What does “Ig” stand for?

Gross (total) Private (business) Domestic (U.S.) Investment

What does Ig include?

• Machinery, equipment, tools

• All construction (residential & commercial)

• Changes in inventories (+/-)

• Creation of new capital assets (e.g., factories)

• R&D and intellectual capital (e.g., software, art)

What does Ig exclude?

Financial transactions like issuing stock — they don’t create new output.

What is the formula for net investment?

Net Investment = Gross Investment − Depreciation.

What does gross investment measure?

Total spending on new capital (how much we put into production).

What does net investment measure?

Growth of capital stock after subtracting depreciation (what’s left to use next year).

If a company starts with $1M in capital, spends $500K on new equipment, and has $200K depreciation, what’s the new capital stock?

• Net investment = $500K − $200K = $300K

• New capital stock = $1M + $300K = $1.3M

What does “G” include in GDP? G means Government Purchases

• Salaries (e.g., teachers)

• Public capital (roads, bridges)

• R&D and services provided by government

What does “G” exclude?

Transfer payments (e.g., Social Security) — they don’t reflect current production

What is the formula for net exports?

Xn = Exports (X) − Imports (M)

Why are exports added to GDP?

They reflect foreign spending on U.S.-made goods — supports domestic production

Why are imports subtracted from GDP?

They represent spending on foreign-made goods — doesn’t count as U.S. output.

What is the full GDP formula using expenditures?

GDP = C + Ig + G + Xn

What does each component represent?

• C = Household consumption

• Ig = Business investment

• G = Government spending

• Xn = Net exports

What percentage of GDP is personal consumption?

More than 2/3

What portion of GDP goes to wages?

A little more than half