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Notes on Nominal and Real GDP

# Notes on Nominal and Real GDP - Notes on Nominal and Real...

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Notes on Nominal and Real GDP Nominal GDP – measures output using current prices. Real GDP – measures output using constant (base year) prices Example – Suppose that the economy of Stapleville produces four goods (bread, beer, wine and cheese) in two different years (Year 1 and Year 2). Beer and wine are substitutes, while the other pairs of goods are complements. The quantities and prices for both years are shown in the tables below: YEAR 1 YEAR 2 Q 1 P 1 Q 1 x P 1 Q 2 P 2 Q 2 x P 2 bread 100 4 400 bread 200 5 1000 beer 200 3 600 beer 400 2 800 wine 300 2 600 wine 200 10 2000 cheese 400 1 400 cheese 600 2 1200 2000 5000 Σ(Q 1 x P 1 ) = Nominal GDP 1 Σ(Q 2 x P 2 ) = Nominal GDP 2 In calculating GDP, we cannot just add up the quantities of output since they are measured in different units. Bread may be measured in loaves, beer in gallons, wine in bottles, and cheese in pounds. To have a common denominator, we must have everything measured in the same units. This is done by multiplying the quantities times the prices, so that we are measuring the market value of each good. When all of the units are measured in dollars, we can meaningfully add them up. Here, nominal GDP for year 1 is \$2000, and nominal GDP for year 2 is \$5000. To calculate the percent change, we can use the following formula. For any variable X, the percent change in X is equal to %ΔX = (X 2 – X 1 ) x 100 X 1 So the percent change in nominal GDP is [ (5000 – 2000) / 2000 ] x 100 = 150% increase. If nominal GDP increased by 150%, does that mean that output increased by 150%? NO! Some of the increase in nominal GDP was due to an increase in output, but some of it was due to an increase in prices. In order to examine output changes, we need a way of keeping prices constant. This is the role of Real GDP, which measures output using

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Notes on Nominal and Real GDP page 2 constant or base year prices. Here, we will assume that year 1 is the base year. Then real GDP will measure output using year 1 prices.
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Notes on Nominal and Real GDP - Notes on Nominal and Real...

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