Methods of calculating national income - Expenditure Method

A cloud service supplied by a foreign provider is an imported service, even though an Indian company makes the payment. The spending may initially appear in domestic expenditure, but it does not represent domestic production. Therefore it is included in imports and subtracted through the net-export term (X − M) to ensure that GDP measures only output produced within the domestic territory.

A firm’s purchase of newly produced machinery adds to the economy’s stock of productive fixed assets. It is therefore included in gross fixed capital formation and counted as investment expenditure. Buying an old house generally transfers ownership of an existing asset, purchasing shares transfers a financial claim, and paying a pension is a transfer payment; none of these directly represents current capital production.

Real investment means expenditure that creates or adds to the stock of physical productive assets, such as new machinery, buildings, or equipment. Such capital formation is counted in national income expenditure. Financial investment, such as buying shares or bonds, transfers ownership of a financial claim and does not itself create a newly produced good. Therefore only real investment is included as investment in GDP accounting.

A newly produced machine is a capital good that adds to the economy’s productive capacity and is included in gross investment or fixed capital formation. Buying an old house does not represent current production, and purchasing shares is a financial transaction rather than production of a good or service. An old-age pension is a transfer payment, not payment for current output. Therefore, the new machine is the correct answer.

Raw material purchased by a firm is an intermediate input used to produce another good or service. Including its full value in private final consumption would be incorrect because it is not household final use and could cause double counting when the final product is counted. Milk, a doctor’s fee, and a book purchased by households can represent final consumption when acquired for household use. Hence option A should be excluded.

Under the expenditure method, GDP is calculated as C + I + G + (X − M). Household consumption (C) may include spending on imported goods, although those goods were produced abroad. Subtracting imports (M) removes this foreign production from total expenditure, while adding exports (X) includes domestically produced goods and services sold abroad. Therefore, net exports ensure that the expenditure total represents domestic production only, which is the basis of GDP.

A government hospital provides health services to the public without charging patients the full market price. The salaries of medical and other staff, together with medicines and other operating inputs used to provide these current services, are treated as government final consumption expenditure. They are not private consumption, financial investment, or net exports because the spending is made by the government for the production and provision of public services.

Payment to a domestic servant represents a market transaction: a service is supplied and a recorded payment is made for it. It can therefore be treated as household consumption expenditure and included in measured production. Unpaid services performed by family members do not normally involve a market transaction or an observable price. National accounting conventions generally exclude such household services from the measured production boundary, even though they have value and contribute to household welfare.

Government salaries are compensation paid for current labour services used to operate public administration and provide government services. They are therefore included in government final consumption expenditure. A newly constructed government building is a fixed asset that will provide productive services over several years, so its purchase or construction is treated as government gross fixed capital formation. Neither item is a transfer payment or private consumption.

Investment in national income accounting refers to expenditure on newly produced capital goods during the current period. The ₹10 lakh spent on new equipment represents current production and is included as gross investment. The ₹2 lakh purchase of old equipment is only a transfer of ownership of an asset produced in an earlier period; counting it again would duplicate its original contribution to output. Therefore, only ₹10 lakh is included, subject to any separately identified current service charges.

An old-age pension is a transfer payment. It transfers purchasing power from the government to a household, but the government does not receive a currently produced good or service in return. Therefore, the pension itself is excluded from current final expenditure and GDP. By contrast, a new car is private final consumption, a new machine is investment, and newly purchased textbooks for public schools represent government expenditure on current goods and services.

Salaries paid to government employees are compensation for current labour services used to produce public administration, education, health, security, and other government services. They are therefore included in government final consumption expenditure. Buying shares or old bonds is a financial transaction and does not represent current production. An old-age pension is a transfer payment, not payment for a currently produced good or service, so it is also excluded from final expenditure.

A gift is a transfer payment: purchasing power is transferred from one person or institution to another without a current good or service being supplied in exchange. The gift itself therefore does not represent current production and is not included in expenditure-based national income. If the recipient later spends the money on a newly produced final good or service, that later purchase is counted under the appropriate category, such as consumption. The original transfer is not counted again.

The new good is produced and purchased for final use in the current year, so its purchase represents current-year final expenditure and is included in GDP through the expenditure method. When the household sells it next year, the good is already used or second-hand; its resale value is not new current production and must not be counted again. Only any new selling or brokerage service connected with the resale could be counted in the later year.

In the expenditure identity, C means final consumption expenditure by households and the government, depending on the classification being used. I means investment expenditure or capital formation, such as purchases of machinery, buildings, equipment, and changes in inventories. Thus option A is correct. Imports and exports are represented by M and X, while taxes, subsidies, transfers, and borrowing are not the meanings of C and I. The standard identity is GDP = C + I + G + (X − M).

A new machine is a real capital good, and its production takes place during the current accounting year. When a domestic firm purchases it, the expenditure is recorded as gross fixed capital formation and contributes to current GDP. A second-hand car was produced in an earlier year, so its resale is not current production. Buying an already issued bond is a financial transaction, and an old-age pension is a transfer payment; neither directly purchases newly produced output.

The components C, I, and G record expenditure according to the purchaser, so they can include imported products. Imports were produced outside the domestic economy and therefore must be removed when calculating domestic product. This is why the expenditure identity includes net exports: GDP = C + I + G + (X − M). Exports are added because they are domestic production purchased by foreigners, whereas imports are subtracted because they represent foreign production included in domestic spending.

An increase in inventories, including unsold finished goods, is treated as investment because the goods have been produced during the current period even though they have not yet been sold to final users. Inventory accumulation is therefore a component of gross capital formation. Pension payments are transfers, purchases of already issued shares are financial transactions, and an imported television is consumption expenditure but not domestic investment. The relevant investment concept concerns additions to real productive assets and stocks.

National income is obtained from domestic income by adding net factor income from abroad: National Income = NDPFC + NFIA. A negative NFIA means that factor payments made to the rest of the world are greater than factor income received from abroad. Adding a negative number lowers the domestic-income figure. Therefore national income is less than NDPFC. It does not become zero unless the numerical values happen to produce zero, and the result is not unaffected.

Health service purchased by a household for satisfaction or final use is private final consumption expenditure, so it is included in final expenditure. Coal bought by a factory, flour bought by a bakery, and packing material bought by a company are intermediate inputs used in further production. Including them separately would cause double counting.

A new tractor is a durable capital good used by the farmer to provide productive services over several years. Its purchase is therefore treated as gross investment, specifically gross fixed capital formation, rather than private consumption. Because it is produced domestically, it is not recorded as an import. Transfer payments do not represent payment for current production.

GDP measures the market value of final goods and services produced within a country’s domestic territory during a specified period, regardless of whether the producers are citizens or foreign residents. Therefore, final expenditure is linked to domestic production. Citizenship, the use of cash, or tax payment is not the defining basis of GDP.

Flour bought by a bakery to make bread is an intermediate input because it is used up or transformed during further production. Its value is already reflected in the value of the final bread, so counting the flour separately would create double counting. Household milk is final consumption, hospital services are government final consumption, and a new machine is investment expenditure.

A new tractor is a fixed, durable capital asset used repeatedly in the production process. Its purchase by a farmer is therefore included in gross fixed capital formation, a component of gross investment. A pension is a transfer payment, vegetables are household consumption, and purchase of an old share is a financial transaction that does not represent current production of a new fixed asset.

Transfer payments are payments made without receiving any currently produced good or service in return. Examples include pensions, scholarships and unemployment benefits. Since they do not represent expenditure on current production, they are not directly included in the expenditure-method formula for GDP. Spending on a new machine, household final consumption and exports is counted because each is related to final goods or services produced during the period.