1 RGDP Here we look at why and how the GDP is converted to RGPD.

2 Potential problem of the GDP measure Let’s start with a very simple example here. Say in our economy only computers are made. Say in year 1 that 10 computers are made and each is sold for $1000. GDP year 1, GDP1 = $1000(10) = $10,000. In year 2 say 12 computers are made and each sells for $1100 for a GDP = GDP2 = $1100(12) = $13200.

3 Potential problem of the GDP measure Now on the previous screen we could take the percentage change in GDP to see the growth in production. To get the percentage change in anything take(later value - earlier value) and divide by the earlier value. So the % change in GDP = ( )/10000 =.32 or 32%. But wait, we went from 10 to 12 computers or a (12-10)/10 =.2 or 20% increase.

4 Potential problem of the GDP measure By looking at the % change in GDP it appears output went up 32%. But we know in this simple example output only went up 20%. The reason the GDP went up more than 20% in our example is because the price level also went up. The price level increasing makes it look like GDP went up more than it did. So the price level change can confuse us about the size of the change in the GDP. In fact it is possible that output falls and prices go up so much that GDP increases, while in fact output fell.

5 Real GDP or RGDP Remember that we take market value in GDP because the list of products is too long. But now using prices may distort the GDP as a measure of production – this is a problem of measurement. Let’s return to the example we had with computers but always use base year prices. The GDP we calculate is called RGDP (say the base year price is $500). RGDP1 = $500(10) = $5,000 RGDP2 = $500(12) = $6,000. The % change in RGDP = ( )/5000 =.2 or 20%. So by using the same prices in both years we only see the % change in output.

6 RGDP Nominal GDP in year t, or GDP in current dollars, uses the prices in year t. RGDP in year t, or GDP in constan t dollars, uses the prices in the base year. Even tough in our simple example we show how RGDP is calculated, when we look at the whole economy a different way is used. Here is how RGDP is calculated RGDP t = (GDP t /price index in year t)100. The price index we use in this calculation is called the GDP deflator. I want you to remember both calculations for getting RGDP.

7 RGDP RGDP is the real gross domestic product and is a broad measure of production or income in a national economy. RGDP is the total value of all goods and services produced in an economy over a period of time and expressed in terms of value that has been adjusted for the general increase in prices. year RGDP in trillions This graph of RGDP is not totally accurate, but has a few features that reflect the true historical record.

8 Let’s note two things about the graph on the previous screen. 1) Over the long haul, or long term, RGDP has moved upward and this is called economic growth. At this time let’s not concern ourselves with why this is so, let’s just note that it is so. 2) In the short term there are economic fluctuations - ups and downs in the level of RGDP. This shorter term pattern is often called the business cycle.

9 Remember the long term shows RDGP grow, but in the short term RGDP goes up and down along the long term trend. Again, the short term fluctuations make a pattern called the business cycle. A recession is a fall in RGDP and as a rule of thumb the decline must occur for at least six months in row to be called a recession. The level of RGDP right before the recession is called the peak and when the recession has stopped the RGDP level is at its trough. From that point the economy expands to the next peak and the cycle begins again. Note that each cycle is not of the same length. During the year 2000 the economy experienced a record in that the longest time had passed by without a recession - something like 9 years. We did have a recession since 2000.

10 When is a recession a depression? When you are the person out of work. :) No, really though, a depression is just a severe or huge recession. The recession is called the Great Depression, and another severe recession hit around So the 1930’s where a pretty tough time in the US from the point of view of RGDP declines. Recessions since this time have been much less severe. The recession was considered tame or mild compared to the experience of the 1930’s. Of course it was hard for some, but we are looking at the big picture here.