Methods of calculating national income - Expenditure Method

A government purchase of newly produced computers for use in government offices is a government-sector final expenditure, not private consumption or domestic income. The precise treatment depends on the economic use: computers used as durable equipment over several years are normally recorded as government gross capital formation, while supplies used up quickly may be treated as government consumption. In either case, the purchase belongs to government expenditure, G, in the expenditure approach.

Foreign tourists are non-residents of India. When they purchase hotel accommodation, transport, or other services within India, Indian producers provide those services to non-residents. National accounting therefore treats the receipts as exports of services, even though the services are consumed in India. In the expenditure identity, these receipts are included in exports, X, and contribute positively through GDP at market prices = C + I + G + (X − M).

Final expenditure must represent spending on currently produced final goods and services. Household consumption, government services, and firms’ purchases of newly produced machinery all correspond to current output and are included respectively in C, G, and investment expenditure. Buying previously issued shares is different: it transfers ownership of an existing financial asset and does not purchase current production. Brokerage or other financial services connected with the transaction may be counted separately, but the share price itself is excluded.

The household’s purchase is final consumption, so its value initially enters private consumption expenditure, C. However, the smartphone was produced abroad and therefore is not part of domestic GDP. Imports, M, are subtracted in the expenditure identity to remove imported goods that may already have been included in C, I, or G. Thus the correct recording is C plus the corresponding deduction under M. This ensures that GDP measures production within the domestic economy rather than total spending by residents.

The economic classification of government expenditure depends on the nature and expected use of the defence equipment, not on the method of payment, the seller’s name, or the tax rate. Equipment that provides a continuing service over several years and qualifies as a fixed asset is recorded as government gross capital formation. Items consumed during current operations may be classified as government final consumption or intermediate use, depending on the accounting framework. Thus option A identifies the relevant criterion.

The purchase of existing company shares is a financial transaction that transfers ownership of an already existing asset. It does not represent the production of a new good or service during the current period, so it is not included in GDP through the expenditure method. In contrast, a newly produced car, a newly constructed hospital, and a new machine represent current production or capital formation.

A newly constructed bridge is a durable asset that provides transport services over many years. Government spending that creates such infrastructure is treated as gross capital formation, specifically public fixed capital formation, rather than government final consumption expenditure. GFCE mainly covers the government’s current consumption of goods and services. The bridge represents investment because it adds to the stock of productive public assets.

PFCE records household spending, so a consumer’s purchase of an imported good can initially appear in consumption expenditure. However, GDP measures production within the domestic territory, and an imported good was produced abroad. Therefore, the value of imports is subtracted from total expenditure. This adjustment removes foreign production from PFCE and ensures that only domestically produced output remains in GDP.

Gross capital formation is a broad investment aggregate. It includes gross fixed capital formation, such as purchases or construction of machinery, buildings, and other durable productive assets, together with the change in inventories or stocks. Thus, GCF is not limited to machines and is not the same as government consumption or net exports. The correct expression is fixed capital formation plus change in stocks.

Gross capital formation is calculated as fixed capital formation plus the change in stocks. The change in stocks is closing stock minus opening stock: 240 − 280 = −40. Therefore, GCF = 900 + (−40) = 860. The negative change means that inventories fell by 40, so it reduces rather than increases total capital formation. Option 940 incorrectly treats the fall in stocks as a positive addition.

Gross Domestic Product measures the market value of final goods and services produced within a country’s domestic territory during a period. It does not depend on whether the producing enterprise is locally or foreign owned. Therefore, production by a foreign-owned company operating inside the country is included in domestic output and GDP. The income sent abroad may affect national measures, but it does not remove the production from GDP.

GDP measures the value of final goods and services produced within a country’s domestic territory during a specified period, regardless of the nationality of the producer. Therefore, when an Indian-owned company produces a good abroad, that production is included in the GDP of the country where it occurs, not in India’s GDP. The expenditure method records expenditure on domestic production, so company ownership or the method of payment does not change the geographical basis of GDP.

Investment expenditure in the expenditure method means spending on newly produced capital goods that add to the economy’s productive capacity or replace existing capital. A firm’s purchase of a newly produced machine is therefore included in gross investment. Buying shares is a financial transaction, not the purchase of currently produced capital goods. A second-hand car was counted when originally produced, and an old-age pension is a transfer payment rather than payment for current output.

Raw material purchased by a firm is normally an intermediate good because it is used as an input in producing another good. Its value becomes part of the price of the final product sold to the ultimate user. If the raw material and the final product were both counted separately in total expenditure, the same value would be counted more than once. Expenditure accounting therefore counts the final product, avoiding double counting.

The expenditure method measures GDP by adding final expenditure on domestically produced output. Its principal components are private final consumption expenditure (PFCE), government final consumption expenditure (GFCE), gross capital formation (GCF), and net exports (NX, equal to exports minus imports). Wages, rent, interest, and profit belong to the income method, while value added belongs to the product method. The other options list aggregates or concepts from different approaches.

Gross domestic capital formation includes expenditure on newly produced capital goods within the domestic territory, such as machinery, equipment, and construction. A firm’s purchase of a newly manufactured domestic machine adds to the capital stock and is therefore included. Buying shares only transfers ownership of a financial claim. A used-car sale does not represent current production, and a pension is a transfer payment rather than expenditure on a newly produced capital asset.

The expenditure identity is GDP at market prices = PFCE + GFCE + GCF + exports − imports. Substituting the given values gives 3300 = 2000 + 600 + 900 + X − 500. The known terms equal 3000 after accounting for imports, so 3300 = 3000 + X. Therefore X = 300. The correct answer is option B; 500 is the value of imports and must be subtracted, not reported as exports.

Consumption expenditure by private non-profit institutions serving households is included with private final consumption expenditure (PFCE) in the expenditure method. These institutions may provide services without a profit objective, but they belong to the private, household-serving sector rather than the government sector. GFCE records government final consumption, NX records exports minus imports, and NFIA is a primary-income adjustment used when moving between domestic and national aggregates, not a consumption component.

Many government services, such as public administration, defence, and certain public health or education services, are supplied free or at prices that do not reflect their economic value. Since there is no reliable market price, national-income accounting values these services by their cost of production, including relevant compensation of employees, intermediate inputs, and other production costs. They are consequently recorded as government final consumption expenditure rather than valued by an assumed profit.

The classification depends on the economic purpose of the purchase. Gold bought for personal use as an ornament provides consumption services and may be included in household final consumption. However, gold bought for resale or as a store of wealth is an investment or asset transaction, not consumption of a current good. Therefore, option B is correct.

Raw materials purchased by a firm are used as inputs in producing another good or service, such as meals served in the employees’ canteen. They are therefore intermediate goods and the related payment is intermediate expenditure. Counting this purchase separately along with the final meal service would cause double counting, so it is not final expenditure.

Change in inventories is calculated as closing stock minus opening stock. If closing inventory is lower than opening inventory, this difference is negative. A negative inventory change means that firms have sold more goods than they produced during the period, so it lowers gross capital formation. Hence, option C is correct.

Domestic product measures the value of final production generated within a country’s domestic territory, regardless of who owns the factors of production. National product adjusts this perspective to the income earned by the country’s normal residents, whether earned at home or abroad. NFIA connects the two concepts: national product equals domestic product plus NFIA.

A research machine or other equipment used repeatedly for more than one production period is a capital good, not a consumer good. The company’s purchase creates or adds to a fixed productive asset, so it is recorded as gross fixed capital formation. Its classification does not depend merely on the word research; the decisive factor is long-term productive use.

GFCE covers the government’s current expenditure on goods and services, including compensation paid to public employees and routine operating services. Construction of a bridge creates a durable public asset and therefore represents capital formation. It should be included in GCF, not GFCE. Thus, classifying bridge construction as GFCE is the incorrect statement.