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KRUGMAN’S Economics for AP® S E C O N D E D I T I O N

Section 3 Module 11

What You Will Learn in this Module Differentiate between real GDP and nominal GDP Explain why real GDP is the appropriate measure of real economic activity Section 3 | Module 11

Real GDP: A Measure of Aggregate Output The most important use of GDP is as a measure of the size of the economy. To measure the economy’s growth with accuracy, we need a measure of aggregate output. The aggregate output is the total quantity of final goods and services the economy produces. Section 3 | Module 11

F Y I Creating the National Accounts The national accounts owe their creation to the Great Depression. All government officials had were scattered statistics. Simon Kuznets developed a set of national income accounts. The first version of these accounts was presented to Congress in 1937 and in a research report titled National Income. The push to complete the national accounts came during World War II. The federal government began issuing estimates of gross domestic product and gross national product in 1942. Section 3 | Module 11

Real GDP: A Measure of Aggregate Output Real GDP is the total value of the final goods and services produced in the economy during a given year, calculated using the prices of a selected base year. Nominal GDP is the value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced. Section 3 | Module 11

Calculating GDP and Real GDP in a Simple Economy Calculating Real GDP Calculating GDP and Real GDP in a Simple Economy Year 1 Year 2 Quantity of apples (billions) 2,000 2,200 Price of apple $0.25 $0.30 Quantity of oranges (billions) 1,000 1,200 Price of orange $0.50 $0.70 GDP (billions of dollars) $1,000 $1,500 Real GDP (billions of year 1 dollars) $1,150 Section 3 | Module 11

Calculating Real GDP Except in the base year, real GDP is not the same as nominal GDP, output valued at current prices. Chained dollars is the method of calculating changes in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year. Section 3 | Module 11

Calculating Real GDP Nominal versus Real GDP in 2000, 2005, and 2013 Nominal GDP (billions of current dollars) Real GDP (billions of 2005 dollars) 2000 $9,951.5 $11,286 2005 12,683 12,638 2013 16,803 14,504 Section 3 | Module 11

What Real GDP Doesn’t Measure A country can have a higher GDP simply by having a higher population. GDP per capita is a measure of average GDP per person, but is not by itself an appropriate policy goal. Real GDP does not include many of the things that contribute to happiness. Section 3 | Module 11

F Y I Miracle in Venezuela? The South American nation of Venezuela has a had one of the world’s fastest-growing nominal GDPs. But, Venezuela has had very high inflation. Section 3 | Module 11

Summary Real GDP is the value of the final goods and services produced calculated using the prices of a selected base year. Except in the base year, real GDP is not the same as nominal GDP, the value of aggregate output calculated using current prices. Analysis of the growth rate of aggregate output must use real GDP. Real GDP per capita is a measure of average aggregate output per person but is not in itself an appropriate policy goal. Section 3 | Module 11