nominal and real GDP

# nominal and real GDP - Dr Fidel Gonzalez(SHSU Topic 5...

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Dr. Fidel Gonzalez (SHSU) Click to edit Master subtitle style Dr. Fidel Gonzalez Department of Economics and Intl. Business Sam Houston State University PRINCIPLES OF MACROECONOMICS Topic 5: Nominal and Real GDP

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Dr. Fidel Gonzalez (SHSU) Click to edit Master subtitle style 22 The GDP is market value of all final goods and services for a given year within a region. If P is the price level of an economy and Q is the production, then GDP = P x Q 2004 2004 2004 2004, For Q P GDP × = Imagine now how it will be for several years (say for 2000 to 2005) Year GDP 2000 P2000 x Q2000= 220 2001 P2001 x Q2001 = 250 2002 P2002 x Q2002 = 280 2003 P2003 x Q2003 = 295 2004 P2004 x Q2004 = 323 2005 P2005 x Q2005 = 337 Most of the time we want to know what happened to Q. That is, we want to know if production went up or down and by how much. Why? Because as I pointed out before production is equal to income. Income is very important because it is a proxy for happiness. Table 1. Nominal GDP
Dr. Fidel Gonzalez (SHSU) Click to edit Master subtitle style 33 However, the table in the previous slide does not help us much. It only tell us what happened to the multiplication of P and Q but not what happened only to Q. For instance from 2003 to 2004 GDP increase by \$28. However, it could have been because production when up and prices went down, or prices went up and production down, or all both went up. In other words, I cannot distinguish between changes in P and changes in Q. In order to solve this problem we are going to calculate GDP using the same price. That is, we are going to use a constant price. This is called Real GDP. Real GDP is the market value of all goods and services for a given year and region using constant prices . Nominal GDP is the market value of all goods and services for a given year and region using current prices .

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Dr. Fidel Gonzalez (SHSU) Click to edit Master subtitle style 44 In order to get constant prices we need to pick one year and that will be the price level that we will use. We can really choose any year we want, so I am going to use the year 2004. The real GDP will then be: Year Real GDP 2000 P2004 x Q2000 2001 P2004 x Q2001 2002 P2004 x Q2002 2003 P2004 x Q2003 2004 P2004 x Q2004 2005 P2004 x Q2005 I multiply each quantity by the same price so the difference of GDPs between two years is due only to change in Q (it is the only thing changing). Note that I have omitted the value of the real GDP because we will do that later. Table 2. Real GDP
Dr. Fidel Gonzalez (SHSU) 55 You can see now that Real GDP is very useful when we compare between years. Also, note that the Real GDP = Nominal GDP for the base year This is one the most important equations of the whole semester and you MUST know it!!!! It is important because it tell us how to compute the Real GDP. It says that if you know the GDP Deflator and the nominal GDP all you have to do is to divide nominal GDP by the GDP deflator and you get Real GDP.

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