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

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Distinguishing Between Nominal and Real Values Comparing GDP Throughout the World

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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 = $4.00 3 apples X $3.00 = $9.00

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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

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

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Compute nominal GDP in each year: 2011:$10 x 400 + $2 x 1000 = $6,000 2012:$11 x 500 + $2.50 x 1100 = $8,250 2013:$12 x 600 + $3 x 1200 = $10,800 PizzaLatte yearPQPQ 2011$10400$2.001000 2012$11500$2.501100 2013$12600$3.001200

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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!.

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Compute real GDP in each year, using 2011 as the base year: PizzaLatte yearPQPQ 2011$10400$2.001000 2012$11500$2.501100 2013$12600$3.001200 $10 $2.00 2011:$10 x 400 + $2 x 1000 = $6,000 2012:$10 x 500 + $2 x 1100 = $7,200 2013:$10 x 600 + $2 x 1200 = $8,400

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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$6000 2012$8250$7200 2013$10,800$8400

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The change in nominal GDP reflects both prices and quantities. year Nominal GDP Real GDP 2011$6000 2012$8250$7200 2013$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.

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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

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

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

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Real GDP (base year 2005) Nominal GDP billions

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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

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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

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Compute the GDP deflator in each year: year Nominal GDP Real GDP GDP Deflator 2011$6000 2012$8250$7200 2013$10,800$8400 2011:100 x (6000/6000) = 100.0 100.0 2012:100 x (8250/7200) = 114.6 114.6 2013:100 x (10,800/8400) = 128.6 128.6 The GDP Deflator for base year is always 100!

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© 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 2011. B. Compute real GDP in 2012. C. Compute the GDP deflator in 2013. 2011 (base yr)20122013 PQPQPQ Good A$30900$311000$361050 Good B$100192$102200$100205

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© 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 2011. $30 x 900 + $100 x 192 = $46,200 B. Compute real GDP in 2012. $30 x 1000 + $100 x 200 = $50,000 2011 (base yr)20122013 PQPQPQ Good A$30900$311,000$361050 Good B$100192$102200$100205

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© 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 2013. Nom GDP = $36 x 1050 + $100 x 205 = $58,300 Real GDP = $30 x 1050 + $100 x 205 = $52,000 GDP deflator = 100 x (Nom GDP)/(Real GDP) = 100 x ($58,300)/($52,000) = 112.1 2011 (base yr)20122013 PQPQPQ Good A$30900$311,000$361050 Good B$100192$102200$100205

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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

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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

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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.

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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

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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

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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.

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