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Learning Targets: Don’t leave here today without knowing how to calculate and use NOMINAL GDP REAL GDP DEFLATOR

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What does GDP measure? The size of the economy in a given year! It meaures the value of all goods made in that country in a single year. If GDP increases, the economy is growing. UNLESS …? REAL GDP vs. NOMINAL GDP

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How might GDP mislead? GDP = the total value (in $) of all products created in a country in a year. Is it possible that GDP could increase even IF there was NO increase in the number of goods and services produced in a country in a given year? – THAT CAN HAPPEN…HOW? INFLATION!

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Imagine an economy with one product. 2013 GDP Country X produced and sold10 cars for $ 50,000 each Country X’s GDP in 2013 was $500,000 (50,000 *10) 2014 GDP Country X again produced and sold 10 cars, but this year, because all prices rose by 20%, they cost $60,000 each. Country X’s GDP in 2014 was $600,000 Country X’s NOMINAL GDP increased but did it’s economy REALLY IMPROVE? NO

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Calculating REAL GDP vs. NOMINAL GDP In order to get a “real” idea of GDP we need to take out the effects of inflation on prices. We calculate REAL GDP by valuing CURRENT Production at BASE YEAR Prices. By calculating the REAL GDP we can see REAL Growth in production from one year to the next, without being fooled by inflation.

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Calculating REAL vs. NOMINAL GDP You Need to Know Formulas The REAL = Nominal - Inflation 1. Nominal GDP (yr X) = Quantity(yr X) * Price(yr X) (Both Q and P are for the same year) 2.To calculate Real GDP, pick a BASE YEAR for your prices. 2.This BASE YEAR remains constant!!! REAL GDP (yr X) = Quantity (yr X) * Price (base year) For Base Year: Real GDP = Nominal GDP

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CALCULATING THE GROWTH RATE IN GDP Now that we’ve calculated real GDP, we can calculate the “rate” of real GDP growth. Find the % Change % Change = (Real GDP yr 2 – Real GDP yr 1/ GDP year 1) *100 This rate of change in REAL GDP is the rate at which the economy is really growing. The U.S. economy must grow at 2% per year to absorb new workers (keep unemployment from increasing)

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Is this a good indicator? What about measuring an economy over time? What Problems will result with this format? Real vs. Nominal GDP NominalReal

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Calculating the Deflator The Deflator shows the amount of inflation from year to year DEFLATOR (yr X) = NOMINAL GDP (yr X) REAL GDP (yr X) The deflator shows the degree to which prices have changed over a period of time. (INFLATION) If… Nominal GDP = Quantity (yr X) * Prices (yr x) and… Real GDP = Quantity (yr X) * Prices (base year) and Deflator = Nominal GDP (yr X)/ Real (yr X) What is the Deflator in the Base year?? In other words… Yr X = Base Year

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Calculating Real GDP using the Deflator Real GDP(yr X) = Nominal GDP (yr X) *100/deflator (yr X) “DEFLATE” ANY NOMINAL NUMBER BY MULTIPLYING BY 100/deflator “INFLATE” ANY NOMINAL VALUE BY MULTIPLYING BY deflator/100

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REAL vs. NOMINAL GDP You Need to Know Formulas 1. Nominal GDP (yr X) = Quantity(yr X) * Price(yr X) (Both Q and P are for the same year) 2. REAL GDP (yr X) = Quantity (yr X) * Price (base year) For Base Year: Real GDP = Nominal GDP 3. DEFLATOR (yr X) = NOMINAL GDP (yr X) REAL GDP (yr X) 4. Now that we’ve calculated real GDP, how do we calculate the “rate” of real GDP growth? Find the % Change in REAL GDP % Change = (yr 2 – yr 1/year 1) *100 4.

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Table 2 Real and Nominal GDP Copyright©2004 South-Western Deflator shows the change in Prices 2002 Inflation = (171-100/100)*100= 71%

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Do Problems and Applications #5, 6 and 7 from page 517 for Monday.

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GDP vs GNP Gross Domestic Product-produced in a country – Y= C+I+G+ (E-M) Gross National Product-produced by a country – GNP= GDP + (Net investment income) – Ie. If America pays more $ in interest to foreign countries than it receives from U.S. Assets held abroad, then its GNP will be lower than its GDP.

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