KW_Macro_Ch_07_Sec_02_Real_GDP_Aggregate_Output

# KW_Macro_Ch_07_Sec_02_Real_GDP_Aggregate_Output - chapter 7...

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>> Tracking the Macroeconomy Section 2: Real GDP and Aggregate Output chapter 7 Although the commonly cited GDP number is an interesting and useful statistic, it is not a useful measure for tracking changes in aggregate output over time. For exam- ple, GDP can rise either because the economy is producing more or simply because the prices of the goods and services it produces have increased. Likewise, GDP can fall either because the economy is producing less or because prices have fallen. In order to separate these possibilities, we must calculate how much the economy has changed in real terms over any given period. That is, we need to calculate how much of the change in GDP is due to a change in aggregate output separate from a change in prices. The measure that is used for this purpose is known as real GDP. Let’s look first at how real GDP is calculated, then at what it means. Calculating Real GDP To understand how real GDP is calculated, imagine an economy in which only two goods, apples and oranges, are produced and in which both goods are sold only to

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final consumers. The outputs and prices of the two fruits for two consecutive years are shown in Table 7-1. The first thing we can say about these data is that the value of sales increased from year 1 to year 2. In the first year, the total value of sales was (2,000 billion × \$0.25) + (1,000 billion × \$0.50) = \$1,000 billion; in the second it was (2,200 billion × \$0.30) + (1,200 billion × \$0.70) = \$1,500 billion, which is 50% larger. But it is also clear from the table that this increase in the dollar value of GDP overstates the real growth in the economy. Although the quantities of both apples and oranges increased, the prices of both apples and oranges also rose. So part of the 50% increase in the dollar value of GDP simply reflects higher prices, not higher production of output. To estimate the true increase in aggregate output produced, we have to ask the fol- lowing question: How much would GDP have gone up if prices had not changed? To answer this question, we need to find the value of output in year 2 expressed in year 1 prices. In year 1 the price of apples was \$0.25 each and the price of oranges \$0.50 each. 2 CHAPTER 7 SECTION 2: REAL GDP AND AGGREGATE OUTPUT TABLE 7-1 Calculating GDP and Real GDP in a Simple Economy Year 1 Year 2 Quantity of apples (billions) 2,000 2,200 Price of apple \$0.25 \$0.30 Quantity of oranges (billions) 1,000 1,200 Price of orange \$0.50 \$0.70 GDP (billions of dollars) \$1,000 \$1,500 Real GDP (billions of year 1 dollars) \$1,000 \$1,150
So year 2 output at year 1 prices is (2,200 billion × \$0.25) + (1,200 billion × \$0.50) = \$1,150 billion. And output in year 1 at year 1 prices was \$1,000 billion. So in this exam-

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## This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_07_Sec_02_Real_GDP_Aggregate_Output - chapter 7...

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