What are the components of GDP under the expenditure approach and how do net exports work?

The expenditure approach is the most commonly tested GDP calculation method on the CFA Level I exam. Let me clarify each component so there's no confusion. **The Formula:** **GDP = C + I + G + (X - M)** Where: - **C** = Personal consumption expenditure - **I** = Gross private domestic investment - **G** = Government spending on goods and services - **X - M** = Net exports (exports minus imports) **Breaking Down Each Component:** **C (Consumption) — typically 65-70% of GDP:** - Durable goods (cars, appliances) - Nondurable goods (food, clothing) - Services (healthcare, education, haircuts) - This is the largest GDP component in most developed economies **I (Investment) — NOT financial investment:** This is the biggest source of confusion. "I" means: - Business spending on equipment and structures (Thornfield Manufacturing buys a $2.5M assembly robot) - Residential construction (new homes being built) - Changes in business inventories - It does **NOT** include buying stocks or bonds — that's financial investment, which is not part of GDP **G (Government Spending):** - Government purchases of goods and services (military equipment, teacher salaries, road construction) - It does **NOT** include transfer payments (Social Security, unemployment benefits, welfare). Transfer payments are just redistribution — the government isn't purchasing a good or service. **X - M (Net Exports):** - X = value of goods and services sold to foreigners - M = value of goods and services purchased from foreigners - If M > X, net exports are **negative**, which **reduces** GDP **Worked Example:** Consider the fictional country of Verdania in 2025 (all figures in billions): | Component | Amount | |-----------|--------| | Consumption (C) | $850 | | Investment (I) | $230 | | Government spending (G) | $280 | | Exports (X) | $175 | | Imports (M) | $210 | | Transfer payments | $95 | **GDP = $850 + $230 + $280 + ($175 - $210)** **GDP = $850 + $230 + $280 + (-$35)** **GDP = $1,325 billion** Notice: the $95B in transfer payments is **not included** in the calculation. **Common Exam Traps:** 1. Including transfer payments in G (wrong!) 2. Treating stock purchases as investment I (wrong!) 3. Forgetting that imports are subtracted 4. Confusing nominal GDP with real GDP — the expenditure approach gives nominal GDP unless prices are adjusted For more macroeconomics practice problems with worked solutions, check out the CFA Level I economics section in our question bank.