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Section 3A

Section 3A. 11. GDP Real vs Nominal. Module. 20.3 NOMINAL GDP VERSUS REAL GDP. Calculating Real GDP Real GDP The value of the final goods and services produced in a given year expressed in the prices of the base year. Nominal GDP

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Section 3A

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  1. Section 3A • 11 • GDP Real vs Nominal • Module

  2. 20.3 NOMINAL GDP VERSUS REAL GDP • Calculating Real GDP • Real GDP • The value of the final goods and services produced in a given year expressed in the prices of the base year. • Nominal GDP • The value of the final goods and services produced in a given year expressed in the prices of that same year. • The method of calculating real GDP changed in recent years, we describe the two methods.

  3. 20.3 NOMINAL GDP VERSUS REAL GDP Traditional Method of Calculating Real GDP • We’ll calculate real GDP in an economy that produces only apples and oranges. The current year is 2006, and the base year is 2000. • Because 2000 is the base year, real GDP and nominal GDP are the same in 2000. • Let’s use the traditional method to calculate real GDP in 2000 and 2006.

  4. 20.3 NOMINAL GDP VERSUS REAL GDP GDP Data for 2000: To calculate real GDP in 2000, sum the values of apples and oranges produced in 2000 using prices in 2000. Value of apples = 60 apples x$0.50 = $30 Value of oranges = 80 oranges x$0.25 = $20 Nominal GDP in 2000 = $30 + $20 = $50

  5. 20.3 NOMINAL GDP VERSUS REAL GDP GDP Data for 2006: To calculate real GDP in 2006, sum the values of apples and oranges produced in 2006 using prices in 2000. Value of apples = 160 apples x$0.50 = $80 Value of oranges = 220 oranges x$0.25 = $55 Real GDP in 2006 = $80 + $55 = $135

  6. 20.3 NOMINAL GDP VERSUS REAL GDP Chained-Dollar Method of Calculating Real GDP • The chained-dollar method does not use the base-year prices. • The chained-dollar method uses the prices of current year and the preceding year. • We show the calculation in fives steps.

  7. 20.3 NOMINAL GDP VERSUS REAL GDP Step 1:Calculate the value of production in both 2005 and 2006 using the prices of 2005. In 2005: Value of apples = 100 apples x$1.50 = $150 Value of oranges = 200 oranges x$0.75 = $150 Nominal GDP in 2005 = $150 + $150 = $300

  8. 20.3 NOMINAL GDP VERSUS REAL GDP In 2006: Value of apples = 160 apples x$1.50 = $240 Value of oranges = 220 oranges x$0.75 = $165 2006 Quantities at 2005 prices = $240 + $165 = $405

  9. 20.3 NOMINAL GDP VERSUS REAL GDP • Using 2005 prices: • Value of production in 2005 is $300. • Value of production in 2006 is $405. • So using 2005 prices, the value of production increased by $105 or 35 percent in 2006.

  10. 20.3 NOMINAL GDP VERSUS REAL GDP Step 2:Calculate the value of production in both 2005 and 2006 using the prices of 2006. In 2005: Value of apples = 100 apples x$1.00 = $100 Value of oranges = 200 oranges x$2.00 = $400 2005 Quantities at 2006 Prices = $100 + $400 = $500

  11. 20.3 NOMINAL GDP VERSUS REAL GDP In 2006: Value of apples = 160 apples x$1.00 = $160 Value of oranges = 220 oranges x$2.00 = $440 Nominal GDP in 2006 = $160 + $440 = $600

  12. 20.3 NOMINAL GDP VERSUS REAL GDP • Using 2006 prices: • Value of production in 2005 is $500. • Value of production in 2006 is $600. • So using 2006 prices, the value of production increased by $100 or 20 percent in 2006.

  13. 20.3 NOMINAL GDP VERSUS REAL GDP • Step 3: Calculate the average of these increases in production: • 35 percent with 2005 prices • 20 percent with 2006 prices • The average of 35 percent and 20 percent is 27.5 percent—our estimate of the real GDP growth rate between 2005 and 2006. • Table 20.6(a) summarizes this calculation.

  14. 20.3 NOMINAL GDP VERSUS REAL GDP

  15. 20.3 NOMINAL GDP VERSUS REAL GDP • Step 4 • Repeat the calculations for each year going back to the base year, so we have an estimate of the real GDP growth rate from the base year of 2000. • Step 5 • Starting from real GDP (nominal GDP) in the base year use the real GDP growth rates to calculate real GDP each through to 2006. • Table 20.6(b) this calculation.

  16. 20.3 NOMINAL GDP VERSUS REAL GDP

  17. 20.3 NOMINAL GDP VERSUS REAL GDP • Calculating the GDP Deflator • GDP deflator • An average of current prices expressed as a percentage of base-year prices. • GDP deflator measure the price level. • GDP deflator = (Nominal GDP  Real GDP)  100.

  18. 20.3 NOMINAL GDP VERSUS REAL GDP We calculated the in 2006: Nominal GDP = $600 and real GDP = $145 GDP deflator = (Nominal GDP ÷ Real GDP) x100 So in 2006: GDP deflator = ($600 ÷ $145) x 100 = 414.

  19. 20.4 THE USE AND LIMITATIONS OF REAL GDP We use estimates of real GDP for two main purposes: • To compare the standard of living over time • To compare the standard of living among countries • The Standard of Living Over Time • To compare living standards we calculate real GDP per person—real GDP divided by the population. • Table 20.8 shows two calculations

  20. 20.4 THE USE AND LIMITATIONS OF REAL GDP

  21. 20.4 THE USE AND LIMITATIONS OF REAL GDP Long-Term Trend Figure 20.3 shows the long-term trend in U.S. real GDP per person. Real GDP per person doubled on the 33 years from 1965 to 1998.

  22. 20.4 THE USE AND LIMITATIONS OF REAL GDP • Short-Term Fluctuations • Fluctuations in the pace of expansion of real GDP is called the business cycle. • The business cycle is a periodic irregular up-and down movement of total production and other measure of economic activity. • The four stages of a business cycle are expansion, peak, recession, and trough.

  23. 20.4 THE USE AND LIMITATIONS OF REAL GDP The shaded periods show the recessions– periods of falling production that lasts for at least six months.

  24. 20.4 THE USE AND LIMITATIONS OF REAL GDP • Standard of Living Across Countries • To compare living standards across countries, we must convert real GDP into a common currency and common set of prices, called purchasing power parity. • Goods and Services Omitted from GDP • Household production • Underground production • Leisure time • Environment quality

  25. 20.4 THE USE AND LIMITATIONS OF REAL GDP • Household Production • Real GDP omits household production, it underestimates the value of the production of many people, most of them women. • Underground Production • Hidden from government to avoid taxes and regulations or illegal. • Because underground economic activity is unreported, it is omitted from GDP.

  26. 20.4 THE USE AND LIMITATIONS OF REAL GDP • Leisure Time • Our working time is valued as part of GDP, but our leisure time is not. • Environment Quality • Pollution is not subtracted from GDP. • We do not count the deteriorating atmosphere as a negative part of GDP. • If our standard of living is adversely affected by pollution, our GDP measure does not show this fact.

  27. 20.4 THE USE AND LIMITATIONS OF REAL GDP • Other Influences on the Standard of Living • Health and Life Expectancy • Good health and a long life do not show up directly in real GDP. • Political Freedom and Social Justice • A country might have a very large real GDP per person but have limited political freedom and social justice. • A lower standard of living than one that had the same amount of real GDP but in which everyone enjoyed political freedom.

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