Gross Domestic Product (GDP) and Consumer Price Index (CPI)

# Nominal GDP and Real GDP

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## Nominal GDP and Real GDP

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Alright let's go into more detail about nominal GDP and Real GDP. So we've been talking about GDP quite a bit up to this point and it's remember the value of final goods and services produced, right final goods and services produced. And we've mentioned two types of calculations phenomenal and real. So nominal GDP it's going to use current prices. The current prices when we're calculating the value of these final goods and services where Real GDP uses what we're gonna call base year prices. So we're gonna be using a constant price when we do Real GDP base year. We're gonna pick some year and say whatever the prices were in that year. We're going to use those prices uh for all the different years calculations of GDP that keeps the price side of the calculation constant and we can measure more the production, the quantity of production. That has changed. Okay so when we first discuss GDP the formal definition we noticed that the expenditures approach right, the G. D. P. Was calculated as consumption plus, you guys should know this by now, What's the Eye? The Eye is investment next government purchases. I'm gonna put gov purchases and finally what's the N. X. Is our net exports. Okay, so that's our formal definition here but a lot of times in this course when they have you calculate nominal GDP and Real GDP they're gonna have some sort of simple economy that's only producing a few goods and they want you to calculate what is the nominal GDP or Real GDP. So what you're gonna wanna do is you're gonna get the quantity of each good, right? The quantity of that good. So phenomenal GDP the quantity of that good. And remember nominal GDP uses current prices, so the current price of that good and we're gonna do that for each good and add them up. So quantity times price gets us the total value of that good quantity times price gets us the total value of the next good and we do that for each of them and add them all together. Notice the only difference with real GDP is that we're using base prices, so quantity of that good this year, Right? However many quantity for the year, we're calculating times the price in the base year. Okay, so quantity times base year price. So the easiest way to see this isn't an example and you're gonna see that this is actually pretty easy to do. And you can expect to see some kind of question similar to this on the Okay, so let's go ahead and go through this one. The simple economy of clutch Topia produces three final goods and services necessary for the survival of its citizens. The clutch Topi ins. So what do they produce? They produce pizza, caffeine pills and exam reviews. So use the information in the following table to compute nominal GDP and Real GDP for 2018. And we're gonna assume They're gonna have to tell you something like this, assume that the base year is 2006. So remember that's gonna come into play when we're doing real GDP. So for the calculation of real GDP will use base year prices nominal GDP we'll just current year prices. So let's go ahead and do nominal GDP and real GDP for 2018. So nominal GDP Put nom GDP. Remember this is for 2018. So we're gonna add up the quantity times the price for each of these. So let's start with pizza here in 2018 we produced 220 pizzas And remember when we're doing nominal GDP we use the current year price. So the current year price was $10 And that will be the GDP from Pizza. And let's add the next one caffeine pills. We had 1500 caffeine pills times the price of $4. And finally In 2018 we had a 130 exam reviews so 100 30 exam reviews times the price of exam, review $20 here and that will give us our nominal GDP when we add those altogether. So let's go ahead and do these one by one, 2, 20 times 10. That gives us a value of 2200 plus 1500 times four is a value of 6000 plus 1, 30 times 20 is a value of 2600. Okay so this isn't too complicated. Right? We're just taking the quantity times the current year price. So let's add all three of those together. 2200 plus 6000 plus 2600 gives us a total value of 10,800. So there is our nominal GDP, right, nominal GDP 10,800. Let's go ahead and do real GDP now. So real GDP for 2018. The only difference in this calculation is going to be the price that we use. So in real GDP we use the base year price which is the price in 2006. So let's go ahead and do that. Now Remember when we're doing the real GDP, we're still using the 2018 production so we still produce 220 pizzas. However, we use the base year price of $8. So that's the trick here. That's the only trick in this calculation is using that base year price. Next we're gonna have the 1500 quantity produced in 2018 for caffeine pills, times the base year price of $5. So notice prices could have gone up or down. So the price of Pizza had gone up, caffeine pills had gone down. Right, so there we have it. Now let's go on to exam reviews had 130 at the base here price of $15. And that's it. That's the whole calculation, we just have to do these three calculations and add them together. So let's go ahead and do it one by 1 to 20 times $8 gives us 1760 Plus 1500 times 5 70 500 plus 1 30 times 15 is 19 51,950. So our final answer for Real GDP, let me get out of the way 17 60 plus 7500 plus 1950. It gives us 11,210 here for our Real GDP. Okay. Real GDP 11,210 And nominal GDP 10,800. So you can expect to have to do a calculation similar to this while you're going through this course. Okay so notice that we're talking about a simple economy, they only produce three products here. So let's go through one more idea here when we're talking about real GDP why it tends to be um generally the more accepted method here. So since Real GDP holds prices constant so it makes it a lot easier for us to compare the G. D. P. In 2018 to say the base year of 2006 or any other year because we're using those same prices each year and we can focus more on that change in quantity, right? It's usually seen as a better measure right, better measure of of changes in production uh rather than nominal GDP. However, there is one drawback is that the prices of of items relative to each other could change. So the change the prices may change relative to each other. So an example is that in 2006 we saw that the price of H HD TVs when they first came out um were more expensive, but as technology has improved, producing HD TVs has been cheaper and the price of HD TVs has come down quite a bit while the price of milk has stayed relatively constant. Right? So this could affect how we look at the value that HD TVs add to GDP compared to milk right, Since the milk has stayed constant. That's not so bad. But how about the HD TVs that the price has gone down? Right? So maybe more HD TVs are selling now, but that's because the price is a lot lower. Okay, so what we do to solve this problem with real GDP using a constant price is we use what's called chain weighted prices. However, that's pretty much beyond the scope of this course. So it kind of adjust the prices and it gives us a little bit better um than just using a current price or a base here, prices kind of extremes, We kind of average it out over time to get a better estimate of what the price should be. Okay. However, overall, you're not going to have to uh do the chain weighted calculation, be more familiar with what we just did above in the example, let's pause here and let's talk about a little more what goes on with nominal GDP and Real GDP in the next video

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## Inflation and the GDP Deflator

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Okay so one use for the nominal GDP and real GDP why we might monitor both of them is to monitor inflation. So inflation. I'm sure you've heard of this word. It's where prices are rising in an economy. Right? So where price levels are generally rising from one year to the next, that's us going through inflation. So we can use nominal GDP and Real GDP to monitor inflation. Okay. And the general price levels. So what we're gonna use is what's called the GDP deflator. And the GDP deflator helps us calculate the inflation rate. So we've got our calculation for both GDP deflator and inflation right here notice GDP deflator, we're gonna have to calculate the nominal GDP in that year and divided by the real GDP in that year. So you can assume when we have inflation that the nominal GDP is going to be higher than the real GDP right? Because the higher prices leads to higher nominal GDP in the current year using current year prices. Um so we'll end up with this number above 100. Right, because this will the numerator will be bigger than the denominator and we'll have this uh measure that shows a higher number here. So we calculate the inflation rate by finding the change in the GDP deflator from one year to the next. So I know it's kind of long year GDP deflator in year two minus GDP deflator in year one over GDP deflator in year one. Well this is just a percentage change calculation. This is just percentage change calculation. Okay. And anytime we do a percentage change calculation it's very easy to do these, you just have to remember a very simple formula where we do new minus old over old. Okay, so to find the percentage change in any situation, we just do the new number minus the old number divided by the old number. So that's the way you want to remember percentage change. New minus old over old and that's exactly what's going on here. New GDP deflator in year two minus old GDP deflator in year one divided by old year one. Okay, So one thing to note about the GDP deflator is that in the base year it will always equal 100. Why is that? Because if we're talking about the base year, well what price level is used in the base here, phenomenal. The base year price. Right, because we're in the base here, the current year is the base here. So the base year price is used here, a nominal. The base here prices used in the real GDP. So we just get the same number in the numerator and denominator times 100 gives us 100. So it's going to equal 100 that's because nominal GDP and real GDP are equal to each other in the base here. Okay, so this isn't too tough. It's just an application of using nominal and real GDP, we're gonna go into a lot of detail of inflation and the implications of inflation in the economy in future videos. But now let's do a little bit of calculations with those numbers. Alright, let's pause here and do some practice.

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Problem

The United States of Barbeque produces two goods:Hot Dogs and Hamburgers. Use the following information to calculate the GDP Deflator for 2012, assuming the base year is 2010.

A

91.30

B

103.11

C

106.19

D

96.98

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Problem

Using the information above, calculate the inflation rate for 2012 in the United States of Barbeque.

A

2.341

B

2.987

C

2.900

D

3.214