National Spending Approach

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Dictionary of Economics

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National Spending Approach

The national spending approach, also known as the expenditure approach, takes all the goods and services that go into GDP and splits them into consumption, investment, and government purchases. It also adjusts for net exports, which is equal to exports minus imports.

What’s the point of splitting GDP up like this? Well, when GDP falls, we want to know why. The factors behind consumption, investment, and government purchases are all very different – as are the tools we might use to boost them.

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What is the "national spending approach"? Well, there are different ways to calculate gross domestic product, but this approach, otherwise known as the "expenditure approach," turns out to be the most common. The national spending approach takes all the goods and services that go into GDP and splits them into consumption -- goods and services like cakes and massages bought by consumers; investment -- goods and services like computers or tractors, usually bought by businesses; and government purchases, which includes consumption goods and services like paper and pens and also investment goods and services like tanks and computers which are bought by governments. We then need to make one correction. People in other countries might also have bought some of our goods, so we add exports. On the other hand, some of what we've counted already, some of what was bought by U.S. consumers, businesses, or governments, was purchased from abroad -- imports. Imports don't add to our GDP, so we want to subtract imports. Exports minus imports is sometimes also called "net exports."

 

Now, how big are each of these categories? Consumption is the biggest, at around 63% of GDP. Investment and government purchases make up the rest, with government purchases usually a bit bigger than investment. In the United States, net exports is usually quite small. It's important to remember that government purchases are different from government spending. When the government spends some tax revenue by sending out, let's say, a social security check, well that's just a transfer -- it doesn't add to GDP. Why not? When the social security recipient gets the check, and spends it on goods and services, well, that does add to GDP, so we don't want to double count it. Remember, government purchases are just the money spent directly by government on goods and services. So why are we doing all this?

 

 

Economists find it useful to split GDP in this way because the forces that determine consumption, investment, and government purchases -- well, they're different, and if GDP falls, we may be interested in knowing -- was that caused by a fall in consumption, or was it a fall in investment or government purchases? If we want to combat a recession, we also have different tools for increasing consumption, investment, or government purchases.

 

 

To learn more about these government tools, click here. Or, to test your knowledge on the national spending approach, click here. Still here? Check out Marginal Revolution University's other popular videos.

 

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