AP® Macroeconomics · Unit 2 · Topic 2.1
The Expenditure Approach to GDP
The expenditure approach adds up everything spent on final goods and services produced in a country in one year, sorted into four buckets: consumption, investment, government spending, and net exports.
Every dollar spent on a final good or service made within a country's borders lands in exactly one of four buckets. Economists split spending this way because each bucket is driven by a different decision-maker and reacts to different forces. Households drive consumption, C: the washing machine you buy, the haircut, the streaming subscription. Businesses drive investment, I: new factories, machinery, software, and also new housing construction. Government drives G: salaries for teachers, fighter jets, road repaving. The rest of the world shows up through net exports, X minus M: what foreigners buy from this country minus what this country buys from abroad. Add the four together and you get GDP, the total value of final output produced in a year.
The formula is GDP = C + I + G + (X - M). Plug in numbers and it is just arithmetic: C of 700, I of 200, G of 300, exports of 150, imports of 250 gives GDP = 700 + 200 + 300 + (150 - 250) = 1,100 billion. Imports get subtracted because C, I, and G already include money spent on foreign-made goods, and that spending did not produce anything domestically, so it has to come back out.
A tricky spot is government bonds. Buying a bond just moves money from a saver to the government in exchange for a future repayment with interest, a financial transaction, not a purchase of a good or service. G only rises when the government actually spends that borrowed cash on something real, like paying a contractor to build a bridge. This same logic of 'did production actually happen' carries into the next idea: unsold inventory. When a firm makes goods nobody buys yet, those goods still count, counted as inventory investment inside I, because production occurred even though a final sale did not.
Key terms
- Consumption (C)
- Household spending on goods and services, the largest component of GDP.
- Investment (I)
- Business spending on capital like factories and equipment, new home construction, and changes in inventories.
- Government spending (G)
- Government purchases of goods, services, and labor, excluding transfer payments and bond purchases.
- Net exports (X - M)
- Exports minus imports, capturing spending by foreigners on domestic goods minus domestic spending on foreign goods.
- Inventory investment
- The value of goods a firm produces but has not yet sold, counted as investment in the year they are made.
Watch it explained
- How it worksWalk me through what lands in C, I, G, and net exports over one year.
- Worked exampleFind GDP when C is 700, I is 200, G is 300, exports are 150, and imports are 250 billion.
- Common mistakeWhy doesn't buying a government bond count as government spending inside GDP?
- Going furtherWhat happens to measured GDP when firms pile up goods they could not sell?
Check yourself
End of topic.