Section 3B- Module 11- Interpreting Real Gross Domestic Product

 Distinguishing Between Nominal and Real Values  Comparing GDP Throughout the World

 Review- GDP measures the total spending on goods and services in all markets of the economy.  If total production and spending rises from one year to the next, at least one of two things must be true. 1. The economy is producing a larger output of goods and services or 2. Goods and services are being sold at higher prices. 2 apples X $2.00 = $ apples X $3.00 = $9.00

 Inflation can distort economic variables like GDP, so we have two versions of GDP:  Nominal GDP  values output using current prices  not corrected for inflation  Real GDP  values output using the prices of a base year  is corrected for inflation

 To calculate Nominal GDP: Current year price X Current year quantity If more than one good/service add them up

Compute nominal GDP in each year: 2011:$10 x $2 x 1000 = $6, :$11 x $2.50 x 1100 = $8, :$12 x $3 x 1200 = $10,800 PizzaLatte yearPQPQ 2011$10400$ $11500$ $12600$

 To calculate Real GDP: Prices of goods/services of base year Quantity of good/services in current year X If more than one good/service then add them up! Remember Real GDP is the same as Nominal GDP in the base year!.

Compute real GDP in each year, using 2011 as the base year: PizzaLatte yearPQPQ 2011$10400$ $11500$ $12600$ $10 $ :$10 x $2 x 1000 = $6, :$10 x $2 x 1100 = $7, :$10 x $2 x 1200 = $8,400

In each year,  nominal GDP is measured using the (then) current prices.  real GDP is measured using constant prices from the base year (2011 in this example). year Nominal GDP Real GDP 2011$ $8250$ $10,800$8400

 The change in nominal GDP reflects both prices and quantities. year Nominal GDP Real GDP 2011$ $8250$ $10,800$8400  The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation.

 To determine the rate of economic growth in GDP from year to year. Real GDP in year 2 - Real GDP in year 1 Real GDP 1 X 100 GDP GROWTH

 The GDP data  Real GDP grows over time  Growth – average 3% per year since 1965  Growth is not steady  GDP growth interrupted by recessions

 Recession  Two consecutive quarters of falling GDP  Real GDP declines  Lower income  Rising unemployment  Falling profits  Increased bankruptcies

Real GDP (base year 2005) Nominal GDP billions

 The GDP deflator  Price index for the macroeconomy that can determine the amount of change in inflation from one year to the next  Measures the current level of prices relative to the level of prices in the base year  IT IS NOT A PRICE!!!  Is 100 for the base year  Can be used to take inflation out of nominal GDP (“deflate” nominal GDP) to give you Real GDP 15

 The GDP deflator is a measure of the overall level of prices.  Definition:  One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next. GDP deflator = 100 x nominal GDP real GDP

Compute the GDP deflator in each year: year Nominal GDP Real GDP GDP Deflator 2011$ $8250$ $10,800$ :100 x (6000/6000) = :100 x (8250/7200) = :100 x (10,800/8400) = The GDP Deflator for base year is always 100!

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Use the above data to solve these problems: A. Compute nominal GDP in B. Compute real GDP in C. Compute the GDP deflator in (base yr) PQPQPQ Good A$30900$311000$ Good B$100192$102200$100205

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A. Compute nominal GDP in $30 x $100 x 192 = $46,200 B. Compute real GDP in $30 x $100 x 200 = $50, (base yr) PQPQPQ Good A$30900$311,000$ Good B$100192$102200$100205

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. C. Compute the GDP deflator in Nom GDP = $36 x $100 x 205 = $58,300 Real GDP = $30 x $100 x 205 = $52,000 GDP deflator = 100 x (Nom GDP)/(Real GDP) = 100 x ($58,300)/($52,000) = (base yr) PQPQPQ Good A$30900$311,000$ Good B$100192$102200$100205

 After you calculate the GDP deflator for each year you can now determine the rate of inflation for the macroeconomy  Inflation rate (calculated from the GDP Deflator)  Percentage change in some measure of the price level from one period to the next 21

 GDP – not a perfect measure of well-being  Doesn’t include  Leisure  Value of almost all activity that takes place outside markets  Quality of the environment  Nothing about distribution of income 22

23  Per Capita GDP  Adjusting for population growth and for price changes  Real GDP per capita is the main indicator of the average person’s standard of living.

24  True Purchasing Power  Accounting for goods and services that are not traded in the world market  Purchasing Power Parity  Adjustments in exchange rate conversions that takes into account differences in the true cost of living across countries

 Rich countries - higher GDP per person  Better  Life expectancy  Literacy  Internet usage  Poor countries - lower GDP per person  Worse  Life expectancy  Literacy  Internet usage 25

26 GDP and the Quality of Life The table shows GDP per person and three other measures of the quality of life for twelve major countries.