BY J. A. SACCO

Section 3B- Module 11- Interpreting Real Gross Domestic Product

MODULE OUTLINE

Distinguishing Between Nominal and Real Values

Comparing GDP Throughout the World

REAL VERSUS NOMINAL GDP

Review- GDP measures the total spending on goods and services in all markets of the economy.

If total production and spending rises from one year to the next, at least one of two things must be true.

1. The economy is producing a larger output of goods and services or

2. Goods and services are being sold at higher prices.

2 apples X $2.00 = $4.003 apples X $3.00 = $9.00

REAL VERSUS NOMINAL GDP

Inflation can distort economic variables like GDP, so we have two versions of GDP:

Nominal GDP values output using current prices not corrected for inflation

Real GDP values output using the prices of a base year is corrected for inflation

NOMINAL GDP

To calculate Nominal GDP:

Current year price X Current year quantity

If more than one good/service add them up

EXAMPLE:

Compute nominal GDP in each year:

2011: $10 x 400 + $2 x 1000 = $6,000

2012: $11 x 500 + $2.50 x 1100 = $8,250

2013: $12 x 600 + $3 x 1200 = $10,800

Pizza Latte

year P Q P Q

2011 $10 400 $2.00 1000

2012 $11 500 $2.50 1100

2013 $12 600 $3.00 1200

REAL GDP To calculate Real GDP:

Prices of goods/services of base year

Quantity of good/services in current yearX

If more than one good/service then add them up!

Remember Real GDP is the

same as Nominal GDP in the base year!.

EXAMPLE:

Compute real GDP in each year, using 2011 as the base year:

Pizza Latte

year P Q P Q

2011 $10 400 $2.00 1000

2012 $11 500 $2.50 1100

2013 $12 600 $3.00 1200

$10 $2.00

2011: $10 x 400 + $2 x 1000 = $6,000

2012: $10 x 500 + $2 x 1100 = $7,200

2013: $10 x 600 + $2 x 1200 = $8,400

EXAMPLE:

In each year, nominal GDP is measured using the (then)

current prices. real GDP is measured using constant prices

from the base year (2011 in this example).

yearNominal

GDPReal GDP

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

EXAMPLE:

The change in nominal GDP reflects both prices and quantities.

yearNominal

GDPReal GDP

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation).

Hence, real GDP is corrected for inflation.

ECONOMIC GROWTH RATE IN GDP

To determine the rate of economic growth in GDP from year to year.

Real GDP in year 2 - Real GDP in year 1 Real GDP 1

X 100

GDP GROWTH

REAL GDP OVER RECENT HISTORY

The GDP data Real GDP grows over time Growth – average 3% per year since 1965 Growth is not steady

GDP growth interrupted by recessions

REAL GDP OVER RECENT HISTORY Recession

Two consecutive quarters of falling GDP Real GDP declines Lower income Rising unemployment Falling profits Increased bankruptcies

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

NOMINAL AND REAL GDP IN THE U.S., 1965–2012

Real GDP (base year

2005)

Nominal GDP

billi

ons

REAL VERSUS NOMINAL GDP

The GDP deflator Price index for the macroeconomy that can

determine the amount of change in inflation from one year to the next

Measures the current level of prices relative to the level of prices in the base year

IT IS NOT A PRICE!!! Is 100 for the base year Can be used to take inflation out of nominal GDP

(“deflate” nominal GDP) to give you Real GDP

15

100xDeflator GDP

GDP nominal GDP Real

THE GDP DEFLATOR

The GDP deflator is a measure of the overall level of prices.

Definition:

One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next.

GDP deflator = 100 x nominal GDP

real GDP

EXAMPLE:

Compute the GDP deflator in each year:

yearNominal

GDPReal GDP

GDP Deflator

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

2011: 100 x (6000/6000) = 100.0

100.0

2012: 100 x (8250/7200) = 114.6

114.6

2013: 100 x (10,800/8400) = 128.6

128.6

The GDP Deflator for base year is always 100!

A C T I V E L E A R N I N G 2

COMPUTING GDP

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Use the above data to solve these problems:

A. Compute nominal GDP in 2011.

B. Compute real GDP in 2012.

C. Compute the GDP deflator in 2013.

2011 (base yr) 2012 2013

P Q P Q P Q

Good A $30 900 $31 1000 $36 1050

Good B $100 192 $102 200 $100 205

A C T I V E L E A R N I N G 2

ANSWERS

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

A. Compute nominal GDP in 2011.

$30 x 900 + $100 x 192 = $46,200

B. Compute real GDP in 2012.

$30 x 1000 + $100 x 200 = $50,000

2011 (base yr) 2012 2013

P Q P Q P Q

Good A $30 900 $31 1,000 $36 1050

Good B $100 192 $102 200 $100 205

A C T I V E L E A R N I N G 2

ANSWERS

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

C. Compute the GDP deflator in 2013.

Nom GDP = $36 x 1050 + $100 x 205 = $58,300

Real GDP = $30 x 1050 + $100 x 205 = $52,000

GDP deflator = 100 x (Nom GDP)/(Real GDP)

= 100 x ($58,300)/($52,000) = 112.1

2011 (base yr) 2012 2013

P Q P Q P Q

Good A $30 900 $31 1,000 $36 1050

Good B $100 192 $102 200 $100 205

REAL VERSUS NOMINAL GDP

After you calculate the GDP deflator for each year you can now determine the rate of inflation for the macroeconomy

Inflation rate (calculated from the GDP Deflator) Percentage change in some measure of the

price level from one period to the next

21

100

Inflation in year 2GDP deflator in year 2-GDP deflator in year 1

GDP deflator in year 1

GDP

GDP – not a perfect measure of well-being Doesn’t include

Leisure Value of almost all activity that takes place

outside markets Quality of the environment

Nothing about distribution of income

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DISTINGUISHING BETWEEN NOMINAL AND REAL VALUES

Per Capita GDP Adjusting for population growth and for

price changes Real GDP per capita is the main indicator

of the average person’s standard of living.

population

GDP Real GDP Real Capita Per

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COMPARING GDPTHROUGHOUT THE WORLD

True Purchasing Power Accounting for goods and services that are

not traded in the world market Purchasing Power Parity

Adjustments in exchange rate conversions that takes into account differences in the true cost of living across countries

INTERNATIONAL DIFFERENCES: GDP & QUALITY OF LIFE

Rich countries - higher GDP per person Better

Life expectancy Literacy Internet usage

Poor countries - lower GDP per person Worse

Life expectancy Literacy Internet usage

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TABLE 3

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GDP and the Quality of Life

The table shows GDP per person and three other measures of the quality of life for twelve major countries.