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 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 = $30 Value of oranges = 80 oranges X $.25 = $20 • Real GDP in 2000 = $30 + $20 = $50
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)
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