Nominal GDP Vs Nominal GDP Vs Real GDPReal GDP

Krugman Section 3 Krugman Section 3

Modules 10 and 15Modules 10 and 15

GDPGDP

Reminder: GDP is a figure Reminder: GDP is a figure including every item produced in including every item produced in the economy. the economy.

MoneyMoney is the common is the common denominator that allows us to denominator that allows us to add the total output.add the total output.

Nominal GDPNominal GDP Is the market value of all final g & s Is the market value of all final g & s

produced in a year.produced in a year. Calculated using current prices when the Calculated using current prices when the

output was producedoutput was produced Includes inflationIncludes inflation It is hard to compare market values from It is hard to compare market values from

year to year when the value of the $ itself year to year when the value of the $ itself changes (inflation or deflation)changes (inflation or deflation) To measure changes in the quantity of output, To measure changes in the quantity of output,

we need a “yardstick” that stays the same size.we need a “yardstick” that stays the same size.

Real GDPReal GDP

The value of the final g & s produced The value of the final g & s produced in a given year expressed in the in a given year expressed in the prices of a base yearprices of a base year 2000 for our example2000 for our example

Nominal Vs Real

Traditional Method of Traditional Method of Calculating GDPrCalculating GDPr

This economy produces apples & orangesThis economy produces apples & oranges The base year is 2000. Since 2000 is the The base year is 2000. Since 2000 is the

base year, real and nominal GDP are the base year, real and nominal GDP are the same.same.

Only during the base year, will the GDPr Only during the base year, will the GDPr and GDPn be the sameand GDPn be the same

To find the GDPr in 2000, + the value of To find the GDPr in 2000, + the value of apples & oranges produced in 2000 using apples & oranges produced in 2000 using the table:the table:

Value of apples = 60 apples X $.50 = $30Value of apples = 60 apples X $.50 = $30

Value of oranges = 80 oranges X $.25 = $20Value of oranges = 80 oranges X $.25 = $20 GDPr in 2000 = $30 + $20 = $50GDPr in 2000 = $30 + $20 = $50

GDP DataGDP Data ForFor 20002000

ItemItem QQ PP

ApplesApples 6060 $.50$.50

OrangesOranges 8080 $.25$.25

To calculate GDPr in 2006, + the value of To calculate GDPr in 2006, + the value of apples and oranges using the prices of 2000apples and oranges using the prices of 2000

Value of apples = 160 apples X $.50 = $80Value of apples = 160 apples X $.50 = $80 Value of oranges = 220 oranges X $.25 = $55Value of oranges = 220 oranges X $.25 = $55 GDPr in 2006 = $80 + $55 = $135GDPr in 2006 = $80 + $55 = $135

Nominal would be?Nominal would be? $600$600

GDP DataGDP Data ForFor 20062006

ItemItem QQ PP

ApplesApples 160160 $1.00$1.00

OrangesOranges 220220 $2.00$2.00

2 purposes of estimating 2 purposes of estimating Real GDPReal GDP

To compare the standard of living over To compare the standard of living over time (based on quantity, not price)time (based on quantity, not price)

To compare the standard of living among To compare the standard of living among countriescountries

Price IndexPrice Index A measure of the price of a specified A measure of the price of a specified

collection of g & s (market basket) in a given collection of g & s (market basket) in a given year as compared to the price of an identical year as compared to the price of an identical collection of g & s in a reference year.collection of g & s in a reference year.

PI = PI = price of market basket for a specific yearprice of market basket for a specific year X 100 X 100 price of same market basket in the base year price of same market basket in the base year

Find GDPr = GDPn / PI X 100Find GDPr = GDPn / PI X 100

GDP DeflatorGDP Deflator An average of current prices expressed An average of current prices expressed

as a percentage of base year prices.as a percentage of base year prices. Measures the price levelMeasures the price level

The average level of pricesThe average level of prices

GDP deflator = (GDPn / GDPr) X 100GDP deflator = (GDPn / GDPr) X 100 Example ($100 / $80) X 100 = GDP Example ($100 / $80) X 100 = GDP

deflatordeflator 1.25 X 100= 125 1.25 X 100= 125

Prices have gone up 25%Prices have gone up 25%

GDPr and the Price LevelGDPr and the Price LevelDeflating the GDP BalloonDeflating the GDP BalloonGDPn increases because of production, GDPr will GDPn increases because of production, GDPr will increase. increase.

GDPr and the Price LevelGDPr and the Price LevelDeflating the GDP BalloonDeflating the GDP BalloonGDPn also increases because prices rise.GDPn also increases because prices rise.

GDPr and the Price LevelGDPr and the Price LevelDeflating the GDP BalloonDeflating the GDP BalloonWe use the GDP deflator to let the air out of the nominal We use the GDP deflator to let the air out of the nominal GDP balloon and reveal GDPr.GDP balloon and reveal GDPr.

The Consumer Price The Consumer Price IndexIndex(CPI)(CPI)

Index the gov’t uses to measure Index the gov’t uses to measure inflationinflation

Gov’t uses it to adjust SS benefits Gov’t uses it to adjust SS benefits and income tax bracketsand income tax brackets

Reports 300 items in a market basketReports 300 items in a market basket Index or base year always = 100Index or base year always = 100

InflationInflation

A rise in the general level of pricesA rise in the general level of prices Inflation rate = Inflation rate = current CPI-Index CPI current CPI-Index CPI = rate (X 100)= %= rate (X 100)= %

index CPIindex CPI

or or Year2 – Year1Year2 – Year1 = rate (X 100) = % = rate (X 100) = %

Year1Year1

oror YearAfter – YearBefore YearAfter – YearBefore = rate (X 100) = %= rate (X 100) = %

YearBeforeYearBefore