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Using real GDP as a measure of actual productivity growth
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Let's say we're studying a very small and oversimplified country that only sells apples, and we measure the GDP in year, one.
We measure that GDP as $1,000.
All of that is due to apples.
We also know that the price of apples in year one was $0.50.
So I'll write it as $0.50 per pound.
Let's say that now year one has gone by and even year two has gone by, and we're able to measure the GDP in year, two.
So, the GDP in year.
Two is $1,200.
And, the price of apples in year two.
Let's just say it is $0.55 a pound.
My question to you, is, GDP, the whole point of measuring GDP, is measuring the productivity of a country.
I mean we are measuring in terms of dollars, but we care more about just the dollar amount.
We really care.
Is, was this country more productive? And.
If it was more productive, how much more productive was it? And? If we just look at these GDP numbers right over here, this $1,000 versus this $1,200, it gives you the sense that-- well, at least if you just look at the numbers-- $1,200- is 20% larger than $1,000.
If you just look at those numbers right over there, it looks like the GDP grew by 20%.
Is that an accurate representation of the productivity of this country? Did? It actually produce 20%, more goods? And.
A big clue is looking at this price here.
Some of this GDP actually might have increased just due to price.
But that doesn't actually make the country more productive., The quantity, the extra quantity of apples that the country produces, is actually what adds to the total productivity.
One way to think about.
It-- Let me draw a little diagram over here.
This axis, I'll do quantity.
This axis, I will do price.
So if I want to figure out the GDP in year, one, I would have the price of apples in year one--.
That's the only good or service, just to simplify things-- times the quantity of apples in year, one.
Then this right over here, the area of this green rectangle, would GDP in year one.
And, then GDP in year.
Two would be the price.
In year, two.
So we're going to go from $0.50 to $0.55.
The price in year, two times the quantity in year, two-- we'll assume some growth as occurred-- times the quantity in year, two.
And so GDP in year.
Two would be the area of this entire rectangle.
If we want to find the difference between GDP in year two and GDP in year one, it would be the difference in area.
It would be what I am shading in, in blue right over here.
And, based on the numbers that we went over right over here, the area that I'm shading in, in blue--.
So the difference between GDP in year two and GDP in year, one, the area I'm shading in blue--- would be this 200.
The 200 increment.
This area right over here would be that 200.
When you look at it over here, you see that that 200, some of it, is due to an increase in quantity.
A lot of it is also due to an increase in price.
If we really wanted to figure out how much more productive, the country got,- and we still want to measure GDP in dollars, maybe we can take a measure of GDP that measures year, two's GDP, but it does it in year, one's prices.
If we could somehow multiply--.
If we could multiply year two's quantity by year, one's prices, then we would get this rectangle right over here.
Then the difference between that and year one, would give us the incremental GDP in year, one prices due to quantity.
And, that's what we care: about.
We care about, total productivity., When, we're thinking about GDP one.
We say how much more productive did the country get? So? Let's try to do it with these numbers right over here.
We can figure out quantity two.
We could figure out the quantity in year, two just by dividing the GDP by the price.
Just by dividing this area of the entire blue rectangle and dividing it by the price, that will give us the quantity.
If we divide 1,200 divided by $0.55--.
Let me get my calculator out.
So if I do 1,200 divided by $0.55.
This is my quantity of apples and in pounds in year, two.
And I'll just round it, 2,182.
This is 2,182.
So the quantity in year two is 2,182 pounds.
This is equal to that.
Then I could multiply this times the price.
This is this quantity.
It's, 2,182, pounds.
And, then I could multiply it times the price.
In year, one at year, one's price.
So I'm, going to multiply it.
Times-- P1 is equal to $0.50 a pound, $0.50 per pound.
This will give me--.
So let me just get my calculator.
I should be able to do that.
One in my head.
But, let's see 0.5.
And I get 1,090.
Obviously, I'll round it to 1,091.
This is equal to 1,091.
This is an interesting number.
This is-- you could view this.
As year, two's GDP., In, year-- or adjusted for-- I'll write, it, adjusted for prices, or adjusted for price increases.
You could say in year one prices.
And, what's useful about this is, this says, look.
If prices had remained constant, this is what our GDP would have gotten.
If prices did not increase.
Our GDP would have gotten to this 1,091.
1,091 is this area that I drew in pink here.
And, so now, you could say if prices were held constant, the growth in GDP would have been $91, not $200.
So this area right over here that I'm-- actually.
Let me do it in a color.
Let me: do it in orange, maybe.
This area right over here, the actual growth.
If prices were held, constant, would have been $91.
We would have gone from $1,000 of GDP to $1,091.
So this right over here.
That area, is $91 of-- and we could even call it real growth.
It, really measures the productivity.
This gives us an interesting, I guess, set of ideas.
One idea is to just measure your GDP in the current year's dollars.
This was GDP.
Measured in year, two's dollars.
It was year two GDP, measured in year two dollars, year, two prices.
We could call that year, two's nominal GDP.
Nominal, in name.
So, it's GDP in name, in that year's prices.
This right over here, where we measured year, two's GDP, in some base year's prices--.
So it allows a real comparison of how much did our productivity, actually increase., Our productivity, actually increased by 9%.
We produced 9%, more apples.
We call real GDP.
It gives you a measure of real productivity.
It tries to take out price increases.
What, we'll see in the future, or we might not do it in an introductory course, but in practice, it's kind of hard to really measure what the absolute--.
This was a simple economy, where we only had one product.
If you have many, many, many products-- actually gazillions of products in a real economy and the prices are adjusting and the quantities are adjusting.
It's not so easy to figure out how to adjust for price.
The folks running the national income accounts do try to do this.
They get a sense of how much was the actual real growth.
GDP that has been adjusted for price changes is called real GDP. If GDP isn't adjusted for price changes, we call it nominal GDP. For example, if real GDP in Year 1 = $1,000 and in Year 2 = $1,028, then the output growth rate from Year 1 to Year 2 is 2.8%; (1,028-1,000)/1,000 = .What are real GDP and nominal GDP ways to measure quizlet? ›
The difference between nominal GDP and real GDP is that nominal GDP: measures a country's production of final goods and services at current market prices, whereas real GDP measures a country's production of final goods and services at the same prices in all years.Would you use real GDP or nominal GDP to accurately calculate growth in 2011? ›
Real gross domestic product (GDP) is a more accurate reflection of the output of an economy than nominal GDP.What is the difference between nominal GDP and real GDP when measuring the national income of a country? ›
Nominal GDP measures the annual production of goods or services at the current price. On the other hand, Real GDP measures the yearly production of goods or services calculated at the actual cost without considering the effect of inflation.How to differentiate between real GDP and nominal GDP using example? ›
Real GDP is the inflation-adjusted GDP of a country. The Nominal GDP of a country is expressed in terms of current year prices of goods and services. The Real GDP of a country is expressed in terms of base year prices or constant prices of goods and services. It is easy to calculate Nominal GDP.What is the difference between real and nominal GDP Why is this important? ›
While nominal GDP by definition reflects inflation, real GDP uses a GDP deflator to adjust for inflation, thus reflecting only changes in real output. Since inflation is generally a positive number, a country's nominal GDP is generally higher than its real GDP.How do you calculate real GDP from nominal GDP? ›
Divide the nominal GDP by the GDP deflator and multiply by 100. This will give you the real GDP.What is the relationship between nominal GDP and real GDP quizlet? ›
What is the difference between Nominal GDP and Real GDP? Real GDP values are adjusted for inflation, while Nominal GDP values are not.How can we use nominal or real GDP to calculate the rate of change? ›
Real GDP can be calculated by taking the difference between the most recent year's real GDP and the prior year's real GDP. Then, divide this difference by the prior year's real GDP. Alternatively, real GDP can be determined if nominal GDP and the prevailing inflation rate are known.Why is real GDP a better measurement than nominal GDP? ›
Consequently, real GDP provides a more accurate portrait of economic growth than nominal GDP because it uses constant prices, making comparisons between years more meaningful by allowing for comparisons of the actual volume of goods and services without considering inflation.
Nominal GDP differs from real GDP in that it does not account for the effects of inflation or deflation. As a result, nominal GDP could inaccurately report true growth when compared year to year. The U.S. Bureau of Economic Analysis reports both real and nominal GDP.Is GDP the accurate valid measure to measure economic growth? ›
GDP is an accurate indicator of the size of an economy and the GDP growth rate is probably the single best indicator of economic growth, while GDP per capita has a close correlation with the trend in living standards over time.What is the difference between real and nominal GDP which is the better measure of economic activity? ›
Nominal GDP is the total value of all goods and services produced in a given time period, usually quarterly or annually. Real GDP is nominal GDP adjusted for inflation. Real GDP is used to measure the actual growth of production without any distorting effects from inflation.
Why is real GDP rather than nominal GDP used when comparing growth over time? Real GDP is used when comparing growth over time because real GDP controls inflation and accurately reflects economic growth.Is nominal or real GDP more accurate? ›
Real GDP offers a better perspective than nominal GDP when tracking economic output over a period of time. When people use GDP numbers, they are often talking about nominal GDP, which can be defined as the total economic output of a country.What is the difference between real GDP and nominal GDP which of the two is the better indicator of welfare and why? ›
Real GDP is a better indicator of economic growth because it can be compared with base year GDP. While nominal GDP cannot be compared to any previous year's GDP.What is the difference between nominal and real? ›
Definition: The nominal value of a good is its value in terms of money. The real value is its value in terms of some other good, service, or bundle of goods.What is the key difference between nominal GDP and real GDP quizlet? ›
The major difference between nominal GDP and real GDP is: nominal GDP measures the value of output in current-year prices, while real GDP measures output using constant prices.Why is it important to use real GDP rather than nominal GDP figures when making comparisons of output across time periods? ›
Real GDP. One thing people want to know about an economy is whether its total output of goods and services is growing or shrinking. But because GDP is collected at current, or nominal, prices, one cannot compare two periods without making adjustments for inflation.What is an example of a nominal GDP? ›
Nominal GDP is derived by multiplying the current year quantity output by the current market price. In the example above, the nominal GDP in Year 1 is $1000 (100 x $10), and the nominal GDP in Year 5 is $2250 (150 x $15).
When you take the nominal GDP and divide it by the current price index and then multiply it by 100 then what are you doing? ›
However, to determine real GDP, the nominal GDP is divided by the price index divided by 100. To simplify comparisons, the value of the price index is set at 100 for the base year.How to calculate nominal GDP with real GDP and inflation rate? ›
The GDP deflator is calculated by dividing nominal GDP by real GDP and multiplying by 100. GDP Deflator Equation: The GDP deflator measures price inflation in an economy. It is calculated by dividing nominal GDP by real GDP and multiplying by 100.What is the relationship between real and nominal GDP growth rates? ›
An increase in nominal GDP may just mean prices have increased, while an increase in real GDP definitely means output increased. The GDP deflator is a price index, which means it tracks the average prices of goods and services produced across all sectors of a nation's economy over time.Which of the following is true of the relationship between real GDP and nominal GDP? ›
The correct answer is (iv) Nominal GDP values production at current prices, whereas real GDP values production at constant prices.Can real GDP and nominal GDP be equal True or false? ›
Real gross domestic products can be equal to nominal gross domestic product. It is possible when price level in both the years is same.What is the difference between nominal and real income? ›
Real income, also known as real wage, is how much money an individual or entity makes after adjusting for inflation. Real income differs from nominal income, which has no such adjustments. Individuals often closely track their nominal vs. real income to have the best understanding of their purchasing power.Why is real GDP more accurate than nominal GDP quizlet? ›
Why is real GDP more accurate than nominal GDP? It is adjusted for price changes. What is one limitation of GDP? It does not measure health and happiness.Why is it difficult to measure real GDP? ›
However, it has some important limitations, including: The exclusion of non-market transactions. The failure to account for or represent the degree of income inequality in society. The failure to indicate whether the nation's rate of growth is sustainable or not.Why is real GDP hard to measure? ›
Data produced quickly tends to be inaccurate; compiling numbers meticulously takes time. Then are the revisions themselves. These take two forms. First, the data used for initial estimates are based on partial information and trend projections.Why are increases in nominal GDP not a good measure of economic growth? ›
Nominal GDP is a misleading indicator of economic growth. This is because, real GDP increase due to increase due to increase in production of an economy whereas nominal GDP shows an increase due to increase in both production capacity or prices, or even sometimes due to pure increase in prices alone.
The most common way to measure the economy is real gross domestic product, or real GDP. GDP is the total value of everything - goods and services - produced in our economy. The word "real" means that the total has been adjusted to remove the effects of inflation.What is more accurate measure than GDP? ›
While gross domestic product (GDP) is among the most popular of economic indicators, gross national income (GNI), is quite possibly a better metric for the overall economic condition of a country whose economy includes substantial foreign investments.Is GDP a perfect measure for measuring economic health True False? ›
In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain many of the inputs into a worthwhile life. GDP is not, however, a perfect measure of well-being. Some things that contribute to a good life are left out of GDP.What is the advantage of real GDP as a measure is the fact that it only increases? ›
Answer and Explanation: Real GDP has the advantage to measure the GDP in that it provides better information about the economic growth than the nominal GDP. It is not always an increasing function as it depends upon the quantity of output produced.What is the biggest difference between nominal GDP and real GDP? ›
Nominal GDP measures output using current prices, while real GDP measures output using constant prices.Does nominal GDP rise faster or slower than real GDP? ›
Answer and Explanation: Nominal GDP in the U.S. has increased faster than real GDP over time because of the ever-increasing products and services prices, which signify a higher inflation rate.What is the reason why there is a difference between the real GDP growth rate and the real GDP per capita? ›
Real GDP takes into account inflation. In other words, Real GDP measures the actual increase in goods and services and excludes the impact of rising prices. Real GDP per capita takes into account the average GDP per person in the economy.Is nominal GDP the more reliable measure for comparing changes in the standard of living over a series of years? ›
Real GDP is more reliable in comparing the standard of living across years because real GDP is only affected by changes in production.What is the fact that nominal GDP has risen faster than real GDP? ›
The fact that nominal GDP has grown faster than real GDP indicates that prices have risen over time. An economy that had real GDP growing faster than nominal GDP would have a falling price level. Changes in inventory capture the value of goods produced this year but not sold until next year.What is the nominal GDP quizlet? ›
Nominal gross domestic product (nominal GDP) is the total market value, measured in CURRENT PRICES, of all final goods and services produced in the economy in a given period of time, usually one year.
For example, if a person's nominal wage is $12.00, their real wage is above or below that amount depending on the current inflation rate. In this situation, a low inflation rate would mean that a person's $12.00 per hour wage could get them more than if they had a $12.00 pay rate during a high inflation period.Which is better real or nominal? ›
Real GDP is a better indicator of economic growth because it can be compared with base year GDP. While nominal GDP cannot be compared to any previous year's GDP.How do you calculate real and nominal? ›
In general, calculating real GDP is done by dividing nominal GDP by the GDP deflator (R). For example, if an economy's prices have increased by 1% since the base year, the deflating number is 1.01. If nominal GDP was $1 million, then real GDP is calculated as $1,000,000 / 1.01, or $990,099.What is nominal GDP for dummies? ›
What Is Nominal Gross Domestic Product (GDP)? The term nominal gross domestic product (GDP) refers to the GDP evaluated at current market prices. Put simply, nominal GDP is the total value of all goods and services produced in a given time period less the value of those made during the production process.What is nominal GDP in simple words? ›
Nominal gross domestic product (GDP) is the value of all the final goods and services at current market prices. In other words, it is the GDP calculated at the current market prices. It takes into account factors such as inflation, price changes, changing interest rates, and money supply at the time of determining GDP.What does real GDP measure? ›
GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced in a country in a given period of time (say a quarter or a year). It counts all of the output generated within the borders of a country.Why is nominal GDP important? ›
Nominal GDP measures the value of the goods and services produced in a country at current prices, providing a snapshot of a country's current output in the current moment. It tells us the present-day value of a country's products and services.What is the formula for nominal GDP growth rate? ›
Nominal GDP = C + I + G + (E – M)
Where, C is the Private consumption. I is the Gross Investment. G is the Government Investment.
There are two ways to calculate the real economic growth rate. Real GDP can be calculated by taking the difference between the most recent year's real GDP and the prior year's real GDP. Then, divide this difference by the prior year's real GDP.