Macro Chapter 6 Presentation 3

Shortcomings of GDP 1. Nonmarket Activities Excluded- ex. The work of a housewife or a carpenter fixing his own home 2. Improved Product Quality- a $200 cell phone now is much better than one from Underground Economy- illegal and off the books activities such as gambling and under the table work 4. No accounting for the negative pollution caused by work 5. Raising GDP does not necessarily improve a country

Disposable Income Personal income minus taxes (state, local, federal income tax, property tax, and inheritance tax)--- Save or Spend whats left

Change in Prices Inflation- a rise in the general level of prices in an economy Deflation- a decline in the economys price level

Nominal GDP The GDP measured using the price of the goods purchased = the sum of: # of units Sold x Price Not adjusted for inflation

Real GDP Adjusted for inflation Inflated (when prices fall) or deflated (when prices rise) to show changes in price level Ex- a hamburger in 1970 sold for $.50 now may sell for $4.00- this is the same amount of output at a higher $$ (deflate this to compare with 1970)

GDP Price Index (GDP Deflator) A measure of the price of a specific collection of goods and services, called a market basket, in a given year as compared to the price of an identical or very similar basket in a reference year The reference year is known as the base year

GDP Price Index Contd. Price index in a given year = (price of market basket in specific year/ price of same basket in base year) x100

Example of Price Index A pizza costs $10 in year 1, the base year. In year 2 the price goes to $20. Price Index = ??? PI = 20/10 x 100 = 200 Rate of change = (new – old)/old x 100 = (( )/100) x 100 That is, the price rose by 100%, since the base year price index always = 100

Finding Real GDP Real GDP = nominal GDP/price index (in hundredths)

Alternative Method Price index (in hundredths) = nominal GDP/Real GDP ***manipulation of the previous formula

GDP Index Example Year Units$Nominal Real Price In $50 $ $140 $ $200 $ ________ ____ ________ ____

Answers- Year 4 Nominal GDP = $30 x 10 units = 300 Price index = price of market basket/basket price base year x 100 = 30/10 x 100= 300 Real GDP = nominal GDP/ price index (hund.) = 300/3.00 = $100

Year 5 Nominal GDP = 11 units x $28 = $308 Price index = (basket price given yr./price of basket in base year) x 100 = 28/10 x 100 = 280 Real GDP = Nominal GDP/price index (hund.) = 308/2.80 = $110