Eye-level MRI
introduction
The explanation below is intended for those with little to no knowledge of economics. The topic of GDP is simple – the explanation is less so, as it requires explaining a new idea that is foreign to most of you. During the explanation, something may bother you, bear with us, everything will be understood in the end. I suggest solving the summary test (true/false questions), re-reading the article and taking the test again. Anyone who gets above 75 on the test can pat themselves on the back, they understand the term GDP better than many economists.
The word GDP is an acronym for the term gross domestic product, with the emphasis on the word product, which needs to be explained. Product is measured in money, in the country’s currency (NIS in Israel, dollars in the US, etc.) and refers to an entire year, unless otherwise noted. Firm in economic jargon: Any business unit is called a firm , such as: a company, a partnership, a grocery store, a kiosk, an independent beautician, etc.
What is a product:
GDP refers solely to everything that the country produces (produces) on its own and by itself, during a year. Remember the obvious: imports are not part of the domestic product, exports are. We will expand on this topic.
Examples:
- In small country A, there are 10 residents who produce 10,000 loaves of bread per year and only loaves of bread. The loaves are produced from only local raw materials (flour, yeast, water, electricity, etc.). The price of each loaf is 10 NIS. The GDP of country A is 100,000 NIS (10 NIS * 10,000 loaves of bread)
- In small country B, there are also 10 residents who produce 12,000 loaves of bread annually from local raw materials, in addition to yeast worth 30,000 NIS that is imported from abroad. The price of each loaf is 10 NIS.
As stated, in the breads of this country, there is an imported component that the country did not distribute itself and therefore it cannot be included in the GDP. Each loaf of bread costs 10 NIS. As stated, in the breads of this country, there is an imported component that the country did not produce itself and therefore it cannot be included in the GDP.
The GDP of country B is calculated as follows: Total value of bread produced: 120,000 NIS minus the value of yeast imported from abroad: 30,000 NIS . Total GDP of country B: 90,000 NIS.
Country B produces more bread than Country A, but due to the import component, its GDP is smaller than that of Country A.
Please note: The meaning of the word product in the context of GDP refers only to the portion of the product produced in a country out of the total output produced there.
National added value
Economists use the term value added in the context of GDP to express, in monetary terms, the country’s contribution to the production of a particular product.
- A carpenter made a table that cost 1000 NIS. To make it, she had to import wood worth 400 NIS. The added value is equal to 600 NIS.
- A diamond polisher imported a rough diamond worth 1,000 NIS. She polished it and sold it for 1,200 NIS. The added value is equal to 200 NIS. The total added value of all the products (and services) that the country created and produced is its GDP.
Calculating GDP
There are 2 ways to calculate GDP.
Method 1: According to the added value of the products as we modeled and calculated in small countries A and B.
Method 2: According to the wages and profits of the firms, as we will immediately present and explain in examples.
Both methods yield the same result as they are 2 sides of the same coin. Wait for the explanation.
An example that combines salary and profits:
In a small country, there are 11 residents who produce 10,000 loaves of bread a year. The price of bread is 10 NIS. One of the residents, named Moshe, aka “Tycoon,” owns a farm called “Hava LeTeferet” and has a modern bakery. The farm grows and produces all the ingredients needed to bake bread (no imports are required). The farm, including the bakery within it, is a firm (business unit), and that is what we will call it later.
All 10 other residents are workers in the firm. The firm only works 10 months a year. During the 2 summer months, it is closed and the workers go on unpaid leave (unpaid vacation). Each worker produces 100 loaves of bread per month and earns 900 NIS (9 NIS per loaf. The tycoon sets the salary). All 10 workers together produce 1,000 loaves of bread per month and 10,000 loaves of bread per year. And earn 90,000 NIS (9 NIS per loaf). The workers buy bread with all kinds of money, the money is enough to buy 9,000 loaves of bread (the price of bread is 10 NIS).
The firm is left with 1,000 loaves of bread, worth 10,000 NIS. This is its annual profit. Of the 1,000 loaves of bread, the tycoon consumes 500 loaves of bread worth 5,000 NIS. Exports 400 loaves of bread worth 4,000 NIS to a neighboring country and stores (save) 100 loaves of bread worth 1,000 NIS.
Calculating the GDP of country C in two ways
Method A is called: national income and is obtained by summing total salaries + firm profits.
The second way is called: GDP uses, or uses for short, and it is obtained by summing the value of uses in GDP (bread consumption + savings + exports).
In method A [national income] the result is 100,000 NIS (salaries 90,000 NIS + firms’ profits 10,000 NIS).
In the second way [uses] the result is 100,000 NIS (consumption of bread, workers and tycoon – 95,000 NIS, savings 1,000 NIS and exports 4,000 NIS).
[mks_highlight color=”#eeee22″]GDP = National Income = Uses[/mks_highlight]
Sources and uses
Sources
In fact, the sources of economic activity of every modern country are two:
- GDP – the product that the country produces itself
- Import – a product received from other countries
Total sources are: GDP + imports.
Uses
It is common to divide the uses into several categories:
- Private consumption (such as bread, milk, purchasing residential apartments, maintaining an apartment, etc.)
- Public consumption (all services provided by government ministries and the public sector)
- Investment products (such as machinery, equipment, and buildings intended for firms.)
- Exports (all goods and services produced in the country and used for export)
There is an equality between sources and uses. As we showed and explained in the previous paragraph, here too the total resources available to the state are equal to the uses made of them.
[mks_highlight color=”#eeee22″]GDP + Imports = Private Consumption + Public Consumption + Investments + Exports[/mks_highlight]
If we move the import component from the right side of the equation to the left side, we get:
[mks_highlight color=”#eeee22″]GDP = Private Consumption + Public Consumption + Investment + [Exports – Imports][/mks_highlight]
GDP in modern countries
In principle, calculating the GDP of a primitive country with 11 inhabitants is similar to calculating the GDP in a modern country with millions of inhabitants, millions of products and services, a public sector with dozens of government ministries, a variety of taxes, duties and fees, and a variety of other activities. The difference lies in the practical aspect of collecting and processing data that comes from thousands of different sources.
The Central Bureau of Statistics (CBSS), which specializes in the subject, is responsible for the calculation. The bulk of its final data is based on samples, estimates, and industry surveys. (This is, of course, a profession in itself).
Sources of information for calculating GDP benefits
Private consumption – is based on firms’ sales to the public.
Public consumption – is based on the salaries of the public sector + the purchases that the sector makes. Such as: vehicles for the police and the army, airplanes, hospital beds for government hospitals, office equipment, cleaning services, etc.
Investment products – based on firms’ purchases and changes in their inventory.
Exports – according to firm reports.
Import – according to customs reports.
Most of the data is based on samples that the HMS conducts.
Data from Israel’s GDP in recent years
| Total GDP | About $400 billion |
| Private consumption | Makes up about 55% |
| Public consumption | Makes up about 23% |
| Investments | Makes up about 22% |
| import | Makes up about 30% |
| export | Makes up about 30% |
| Export-Import | Makes up about 0% |
| Total gross salaries | Makes up about 70% |
| Total gross profits of firms | Makes up about 30% |
Growth – For example, if GDP in year one was 100 NIS and in year two was 105 NIS, we say that GDP grew by 5%.
Negative growth – When GDP decreases in year two, we say that GDP is declining or that there is negative GDP growth .
Repetition and completion
Every output of any business unit in the country (a limited company, partnership, small self-employed person, shopkeeper, etc.) is included in GDP. Since GDP is measured in money, it is not practical to include in GDP activities that do not involve monetary payment, such as: work by a housewife, work done voluntarily without payment, as well as payment to a plumber without a receipt, etc. Also included in GDP are the activities of all government ministries and the public sector in all its branches.
GDP is calculated in two different ways, which theoretically reach the same result.
Way 1: National income (total gross salaries + total gross corporate profits)
The gross profit of firms indicates that the amount stated is before payments of taxes, duties, fees, and various provisions to the various state authorities.
Path 2: Uses (private consumption + public consumption + investments + [exports – imports])
The value of goods (and services) produced in that year.
Final products
Products that are not raw materials for the production of another product. A package of butter used to make a Napoleon cake in a confectionery is not a final product. A package of butter that David bought to spread on a sandwich is a final product.
Only final products are included in GDP, in order to prevent duplication that would be reflected in “inflating GDP” – once as a raw material and once in the final product. If the butter component in a Napoleon cake is worth 10 NIS and the cake is sold for 50 NIS, then its contribution to GDP is only 50 NIS and not 10 NIS + 50 NIS. The package of butter that David bought to spread on his sandwich adds 10 NIS to GDP.
National added value versus factory added value
National added value
[Total country output less imports]
Value added factories
[Total factory sales minus purchases]
There is no distinction whether the purchases are imported or locally produced (which do not contain even a single shekel of imports). The purchases also include electricity, water, and depreciation. They do not include wages.
Answer a short questionnaire
To check whether you understood the article, answer the following short questionnaire:
[WpProQuiz 335]
Completing the article
Now that we understand the term GDP and how it is calculated, we can delve further into understanding the significance of GDP for a country’s economy. GDP not only reflects the economic activity in a country, but also affects other economic indicators such as employment, investment, and social welfare.
GDP and its impact on employment
When a country’s GDP increases, it usually has a positive effect on employment. When businesses produce more goods and services, they need more workers. This can lead to a decrease in the unemployment rate and an improvement in the standard of living of citizens. Conversely, when GDP decreases, businesses may reduce the number of employees, which can lead to an increase in unemployment and a decrease in economic well-being.
GDP and investments
A high GDP can also attract foreign investment. Investors tend to look for countries with growing economies, as this indicates the potential for high profits. Foreign investment can contribute to a country’s economic growth, create new jobs, and improve infrastructure.
GDP and social welfare
GDP is also an important indicator when it comes to social welfare. Countries with high GDP tend to invest more in public services such as education and healthcare. This can lead to an improvement in the quality of life of citizens and a reduction in social gaps. However, it should be remembered that high GDP does not always reflect high social welfare, as there are other indicators that need to be taken into account, such as income gaps, environmental quality, and the level of education.
summary
In conclusion, GDP is a key indicator for understanding a country’s economic activity. It provides insights into employment, investment, and social welfare. Understanding the term and its calculation processes is essential for anyone interested in understanding the modern economy and the challenges it poses.
Now that you have understood the article, you are invited to try answering the short questionnaire mentioned earlier, to test your understanding of the subject.