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…
oIncrease in quantity (volume) of g & s
oIncrease 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
•Real GDP is measured using constant price from 2004, therefore, only quantity changes
oAs 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.
GDP Deflator = 100 x (nominal GDP/real GDP)
This is a way to measure the inflation rate:
•Compute the % change of the GDP Deflator