You wake up in the morning to an inviting steamy cup of tea or coffee as you flip through the daily newspaper whose headline ecstatically proclaims “Economy recovers as GDP rebounds”. You go about your daily chores bracing yourself for the day that lies ahead. You don the immaculate white formal shirt that was a steal in that factory outlet sale the last weekend. You grab a quick cheese sandwich and rush out to your car and notice that you will have to refuel it. You stop by at the gas station before heading to your office. Glancing at your watch hurriedly as you navigate through the traffic labyrinth, you think that you should be able to make it for an important meeting with a business client scheduled in about an hour. Sounds like just another morning? Did you realize that since morning you have contributed to your country’s Gross Domestic Product (GDP) in more than one way for sure. Right from your morning tea, the newspaper, your breakfast, fuel for your car, and the business deal to be finalized with your client, all have an important bearing on the economy of your country.
Looking at all these activities closely you see that they are all expenditures involving spending, whether on individual consumption or business investment. This is precisely how GDP is measured through the Expenditure Approach, as is represented in the equation:
GDP = C + I + G + (X-M)
This equation primarily gives the four main sources of expenditure in an economy: private consumption (C), business investment (I), government (G) and the foreign sector (X-M). Private consumption may range from food, fuel, housing, to services like education, health, recreation and the like. Next we have investment expenditures, which consist of expenditure on capital like buildings, plant and machinery, which enhances productive capacity. The government also undertakes several expenditures such as in large-scale infrastructure projects, or for the provision of a wide range of goods, services, and most commonly, public utilities to citizens. Then of course we have foreigners who also create a demand for our goods or services, the (X-M) factor. This is net exports- which includes exports and excludes imports.
What is spent as expenditures by us on goods and services goes as incomes to people who have put in their efforts in producing those goods and services. So owners of labour get income, owners of land get rent, providers of capital or money earn interest and entrepreneurs get profits. So another way of measuring the GDP is through summing up the incomes of all entities involved in production, in other words the Income Approach of measuring GDP.
Let us continue this story one step further. These entities earn incomes for being involved in the production process. The production of goods and services. So this brings us to the third approach of measuring GDP- The Production Approach. This is well-explained through the much-used, standard definition of GDP, which is ‘The market value of all final goods and services produced in a country during a year.’
These approaches are all linked in a circular manner. You may start anywhere, the process of GDP measurement through one approach, logically takes you to the other two. For instance, lets start with production. Production of goods and services generates incomes for the people involved in their production. And these incomes are converted into expenditures on the goods and services produced. Now lets start with expenditures. The expenditures on goods and services go out as incomes for the people involved in their production. This facilitates further production, maintaining the circular flow in the economy. Similar is the case when we start with incomes. The incomes earned are spent on goods and services, in other words, they go out as expenditures. These very expenditures keep the production process going, that is, we spend hence there is ongoing production in the economy.
Thus a nation’s income can be estimated from three angles-
At any point of time we realize that we are involved in at least one of the above three in some way or the other. However minuscule be the outcomes of our actions, what remains true is our inextricable link to the economy and its GDP. Truly, Economics is the life of business and the business of life.