c22b-ep - A price index is a measure of the average level...

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22.b. Price Indexes and GDP Deflator Nominal variables are variables that are measured in terms of current market values. Using market values to measure economic activity is an advantage that allows different types of goods and services to be summed up. But a problem arises if you want to compare the values of an economic variable at two different points in time. If GDP changes over time, you can’t tell whether changes are reflected by the change in quantity or prices of goods and services. Economic variable is measured by prices in a base year, called real variable. Real economic variables measure quantity of economic activity. Real GDP measures the physical volume of an economy’s final production using base year. Nominal GDP is the dollar value of an economy’s final output measured at current market prices. Real GDP and nominal GDP are equal in the base year.
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Unformatted text preview: A price index is a measure of the average level of prices for some specified set of goods and services, relative to the prices in a specified year. GDP deflator is a price index that measures the overall level of prices of goods and services included in GDP. It is often given in the formula: Real GDP = nominal GDP/GDP deflator (22.1) The GDP deflator is the amount that nominal GDP is divided by to obtain real GDP. You can rewrite the equation as: GDP deflator = nominal GDP/ real GDP. (22.2) In the first year, nominal and real GDP are equal. That means that the GDP deflator equals to 1. Lets say that in year 2, nominal GDP is $35,000 and real DGP is $30,000. That means that the GDP deflator for year 2 is $35,000/30,000 = 1.1667. The overall level of prices, measured by the GDP deflator, is 16.67% higher in year 2 than in year 1....
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This note was uploaded on 09/25/2008 for the course ECON 160 taught by Professor Baim during the Summer '98 term at UCLA.

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