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Western University
Economics 2152A/B
Jennifer Mori

Nominal and Real Price IndicesWhen we calculate GDP we are using a set of prices and quantities This calculation gives us the value of GDP in the current year But what if we want to compare two years Suppose in year 1 GDP is 1000000 and in year 2 it is 2000000Does this mean the economy has grown 100 in a yearMaybe but what if all that happened was the price of everything doubled So that a pair of shoes that cost 100 dollars now costs 200 and milk that cost 150 now costs 300 etc in other words suppose that all prices doubled but that the quantity of goods in the economy remained the same this is just a thought experiment Our calculation would show a NOMINAL change in GDP from one million to two million but nothing more was actually produced no REAL change in GDPWhen we look at economies we are usually interested in real changes since it the real changes that affect the living standards of individuals in the economyTherefore we need a method of determining the real changes in GDPThere are two ways to compute real GDPOne is the fixed base year method and the other is to use a chain weightThe more important of these two is the chainweighting method since this the one that is used in practiceIn order to measure real changes in GDP we use a price index The price index allows us to sift out changes in GDP that are due solely to price ie nominal changeThe first price index we will look at is called the GDP deflatorThe GDP deflator is calculated as follows DeflatorNominal GDP Real GDPX 100 Lets suppose we have a two commodity economythe proverbial apples and oranges
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