Nominal GDP Vs Real GDPPart II of Unit 3measuring domestic output

GDPReminder: 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 GDPIs the market value of all final g & s produced in a year.Calculated using current prices when the output was producedIncludes inflationIt 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 GDPThe value of the final g & s produced in a given year expressed in the prices of a base year2000Nominal Vs Real

Traditional Method of Calculating Real GDPThis economy produces apples & orangesThe base year is 2000. 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 = $30Value of oranges = 80 oranges X $.25 = $20Real GDP in 2000 = $30 + $20 = $50

GDP DataFor2000ItemQPApples60$.50Oranges80$.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 = $80Value of oranges = 220 oranges X $.25 = $55Real GDP in 2006 = $80 + $55 = $135Real GDP is constant dollars or 2000 dollars measure (taken inflation out)

GDP DataFor2006ItemQPApples160$1.00Oranges220$2.00

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

Price IndexA 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 100PI

GDP DeflatorAn average of current prices expressed as a percentage of base year prices.Measures the price levelThe average level of pricesGDP deflator = (NGDP / RGDP) X 100($135 / $50) X 100 = GDP deflator2.7 X100 = 270If NGDP rises but RGDP remains unchanged, prices have risen.

Real GDP and the Price LevelDeflating the GDP BalloonNominal GDP increases because productionreal GDP increases.

Real GDP and the Price LevelDeflating the GDP BalloonNominal GDP also increases because prices rise.

Real GDP and the Price LevelDeflating the GDP BalloonWe 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 govt uses to measure inflationGovt uses it to adjust SS benefits and income tax bracketsReports 300 items in a market basket

InflationA rise in the general level of pricesInflation rate = current CPI-Index CPI = rate (X 100)= %index CPI

or Year2 Year1 = rate (X 100) = % Year1