Nominal GDP Vs Real GDP Part II of Unit 3—measuring domestic output

GDP  Reminder: GDP is a figure including every item produced in the economy.  Money is the common denominator that allows us to add the total output.

Nominal GDP  Is the market value of all final g & s produced in a year.  Calculated using current prices when the output was produced  Includes inflation  It is hard to compare market values from year to year when the value of the $ itself changes (inflation or deflation)  To measure changes in the quantity of output, we need a “yardstick” that stays the same size.

Real GDP  The value of the final g & s produced in a given year expressed in the prices of a base year  2000 Nominal Vs Real

Traditional Method of Calculating Real GDP  This economy produces apples & oranges  The base year is Since 2000 is the base year, real and nominal GDP are the same.

 To find the real GDP in 2000, + the value of apples & oranges produced in 2000 using the table: Value of apples = 60 apples X $.50 = $30 Value of oranges = 80 oranges X $.25 = $20  Real GDP in 2000 = $30 + $20 = $50 GDP Data For2000 ItemQP Apples60$.50 Oranges80$.25

 To calculate real GDP in 2006, + the value of apples and oranges using the prices of 2000  Value of apples = 160 apples X $.50 = $80  Value of oranges = 220 oranges X $.25 = $55  Real GDP in 2006 = $80 + $55 = $135  Real GDP is “constant dollars” or “2000 dollars” measure (taken inflation out) GDP Data For2006 ItemQP Apples160$1.00 Oranges220$2.00

2 purposes of estimating Real GDP  To compare the standard of living over time (based on quantity, not price)  To compare the standard of living among countries

Price Index  A measure of the price of a specified collection of g & s (market basket) in a given year as compared to the price of an identical collection of g & s in a reference year.  PI = price of market basket for a specific year X 100 price of same market basket in the base year  Find Real GDP = Nominal GDP X 100 PI

GDP Deflator  An average of current prices expressed as a percentage of base year prices.  Measures the price level  The average level of prices  GDP deflator = (NGDP / RGDP) X 100  ($135 / $50) X 100 = GDP deflator  2.7 X100 = 270 If NGDP rises but RGDP remains unchanged, prices have risen.

Real GDP and the Price Level  Deflating the GDP Balloon  Nominal GDP increases because production— real GDP– increases.

Real GDP and the Price Level  Deflating the GDP Balloon  Nominal GDP also increases because prices rise.

Real GDP and the Price Level  Deflating the GDP Balloon  We use the GDP deflator to let the air out of the nominal GDP balloon and reveal real GDP.

The Consumer Price Index (CPI)  Index the gov’t uses to measure inflation  Gov’t uses it to adjust SS benefits and income tax brackets  Reports 300 items in a market basket

Inflation  A rise in the general level of prices  Inflation rate = current CPI-Index CPI = rate (X 100)= % index CPI or Year2 – Year1 = rate (X 100) = % Year1 Year1