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ECON1000 CH. 6.docx

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ECON 1000
Nick Rowe

Measuring a Nations Income Continued Gross Domestic Product: measures the market value of all final goods and services produced within a country in a given period of time, used how to judge how the economy is performing, sheds light on whether the economy is expanding, contracting of stagnant Nominal GDP, Real GDP & GDP Deflator There are two versions of GDP because inflation can distrort economic variables like GDP. One is corrected for inflation and the other is not. • Nominal GDP: values output at current prices. It is not corrected for inflation. • Real GDP: values output at constant prices of a base year. It is corrected for inflation • GDP Deflator: in addition, a GDP deflator can be used to measure inflation. It is a measure of index of the overall level of prices. Why bother with different versions of GDP? Nominal GDP can be represented as follows: GDP = (P1 x Q1) + (P2 x Q2) + … (Pn x Qn) ...where P1 and Q1 is the price and quantity of good 1 and so on • Nominal GDP can increase year over year because… o Increase in quantity (volume) of g & s o Increase in prices (price level) • Important for decision makeers to know why GDP increased or fell Example: Economy producing Pizzas and Lattes Pizza Pizza Latte Latte year P Q P Q 2004 $10 400 $2.00 1000 2005 $11 500 $2.50 1100 2006 $12 600 $3.00 1200 To compute real GDP in each year: 2004: $10 x 400 + $2 x 1000 = $6000 (use 2004 as a base year) 2005: $10 x 500 + $2 x 1100 = $7200 (20% increase) 2006: $10 x 600 + $2 x 1200 = $8400 (16.7% increase) In each year… • Nominal GDP is measured using the (then) current prices--both quantity and price change • Real GDP is measured using constant price from 2004, therefore, only quantity changes o As if there was zero inflation and hence, real GDP is corrected for inflation The GDP Deflator A measure or index of the overall level of prices. EQ: GDP Deflator = 100 x (nominal GDP/real GDP) This is a way to measure the inflation rate: • Compute the % change of the GDP Deflator 2004: 100 x (6000/6000) = 100% 2005: 100 x (8250/7200) = 114.6% (increase of 14.6%) 2006: 100 x (10,800/8400) = 128.6% (increase of 12.2%) Question: Calculate Real GDP Year Nominal GDP GDP Deflator 2007 180 105 2008 200 125
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