5. Real versus nominal GDP Consider a simple economy that produces two goods: pe

Question

5. Real versus nominal GDP Consider a simple economy that produces two goods: pencils and muffins. The following table shows the prices and quantities of the goods over a three-year period Pencils Muffins Price Quantity (Number of pencils) 125 170 150 Price Year 2012 2013 2014 Quantity (Number of muffins) 200 230 170 (Dollars per pencil) (Dollars per muffin) Use the information from the preceding table to fill in the following table. Nominal GDP Dollars) Real GDP Year 2012 2013 2014 (Base year 2012, dollars) GDP Deflator From 2013 to 2014, nominal GDP and real GDP The inflation rate in 2014 was Why is real GDP a more accurate measure of an economy's production than nominal GDP? Real GDP includes the value of exports, but nominal GDP does not. Real GDP measures the value of the goods and services an economy produces, but nominal GDP measures the value of the goods and services an economy consumes. Real GDP is not influenced by price changes, but nominal GDP is

Explanation / Answer

YEAR 2012

Calculate the nominal GDP -

Nominal GDP = (Price of pencil in 2012 * Quantity of pencils in 2012) + (Price of muffins in 2012 * Quantity of muffins in 2012)

Nominal GDP = ($1 * 125) + ($1 * 200) = $125 + $200 = $325

The nominal GDP in 2012 is $325

Calculate the real GDP -

Real GDP = (Price of pencil in 2012 * Quantity of pencils in 2012) + (Price of muffins in 2012 * Quantity of muffins in 2012)

Real GDP = ($1 * 125) + ($1 * 200) = $125 + $200 = $325

The real GDP in 2012 is $325

Calculate the GDP deflator in 2012 -

GDP deflator = (Nominal GDP/Real GDP) * 100 = ($325/$325) * 100 = 100

The GDP deflator in 2012 is 100.

YEAR 2013

Calculate the nominal GDP -

Nominal GDP = (Price of pencil in 2013 * Quantity of pencils in 2013) + (Price of muffins in 2013 * Quantity of muffins in 2013)

Nominal GDP = ($2 * 170) + ($4 * 230) = $340 + $920 = $1,260

The nominal GDP in 2013 is $1,260

Calculate the real GDP -

Real GDP = (Price of pencil in 2012 * Quantity of pencils in 2013) + (Price of muffins in 2012 * Quantity of muffins in 2013)

Real GDP = ($1 * 170) + ($1 * 230) = $170 + $230 = $400

The real GDP in 2013 is $400

Calculate the GDP deflator in 2013 -

GDP deflator = (Nominal GDP/Real GDP) * 100 = ($1260/$400) * 100 = 315

The GDP deflator in 2013 is 315.

YEAR 2014

Calculate the nominal GDP -

Nominal GDP = (Price of pencil in 2014 * Quantity of pencils in 2014) + (Price of muffins in 2014 * Quantity of muffins in 2014)

Nominal GDP = ($4 * 150) + ($4 * 170) = $600 + $680 = $1,280

The nominal GDP in 2014 is $1,280

Calculate the real GDP -

Real GDP = (Price of pencil in 2012 * Quantity of pencils in 2014) + (Price of muffins in 2012 * Quantity of muffins in 2014)

Real GDP = ($1 * 150) + ($1 * 170) = $150 + $170 = $320

The real GDP in 2014 is $320

Calculate the GDP deflator in 2014 -

GDP deflator = (Nominal GDP/Real GDP) * 100 = ($1280/$320) * 100 = 400

The GDP deflator in 2014 is 400.

Following is the complete table -

From 2013 to 2014, nominal GDP increases, and real GDP decreases.

Calculate the inflation rate in 2014 -

Inflation rate = [(GDP delfator in 2014 - GDP deflator in 2013)/GDP deflator in 2013] * 100

Inflation rate = [(400 - 315)/315] * 100 = 26.98%

The inflation rate in 2014 was 26.98%.

Real GDP is a more accurate measure of an economy's production than the nominal GDP because real GDP is not influenced by the price changes, but nominal GDP is.

Hence, the correct answer is the option (3).

Year Nominal GDP Real GDP GDP deflator 2012 $325 $325 100 2013 $1,260 $400 315 2014 $1,280 $320 400

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