Real GDP and Nominal GDP Using real GDP as a measure of actual productivity growth
Real GDP and Nominal GDP
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- lets say were studying a simple and oversimplified country that only sells, only sells apples and we measure the GDP in year one
- and we measure that gdp as 1000 dollars. And all of that is due to apples. And we also know the price of apples in year 1 were 50 cents a pound.
- So I'll write it as 50 cents per pound and lets say now that year 1 has gone by and now even year 2 has gone by and were able to mesure the GDP in year 2.
- So GDP in year 2 is 1200 dollars and the price of apples in year two, lets just say it is 55 cents a pound, 55 cents a pound. So my question to you is
- GDP; the whole point of measuring gdp is measuring the productivity of a country. Were measuring in terms of dollars, but
- we care more about the dollar amount and if this country was more productive and if it was
- more productive how much more productive was it. And if we look at these GDP numbers right over here this 1000 dollars vs this 1200. It gives you the sense that
- well atleast if you just look at the numbers. 1200 is 20% larger than 1000 dollars. So if you just look at those numbers, it looks like the gdp grew by 20%. So is that an accurate representation of the productivity of this country?
- Did it actually produce 20 percent more goods and a big clue is looking at this price here, bc some of this GDP actually might have just increased due to price.
- But that doesn't make the country more productive. The extra quantity that the country produces, is actually what adds to the total productivity. One way to think about it, let me draw a little diagram here.
- On this axis we will have quantity and this axis I will do price. So in year one, if we want to find the gdp in year 1 I would have the price of apples in year one.
- Thats the only good or service times the quantity of apples in year one and then this right over here. The area of this green rectangle would be GDP in year 1
- GDP in year 1 and then GDP in year 2 would be the price in year 2 so were gonna go from 50 cents to 55 cents. the price in year two timest the quantity in year two. We'll assume some growth has occurred.
- Times the quantity in year two. So GDP in year 2 would be the area of this entire rectangle. So if we want to find the difference between year 2 and year 1, it would be the difference in area. So it would be what I am shading in in blue right here.
- And based on the numbers we went over right over here, the area that im shading in right is blue. So the difference between GDP in year 2 and year 1 would be this 200 increment. So this area right over here would be that 200.
- Now when you look at over here you see that that 200 some of it is due to an increase in quantity some of it is due to an increase in quantity but alot of it is due to increase in price. So if we really wanted to figure out how much more productive the country
- got, and we still want to measure GDP in dolllars, maybe we could take a measure of GDP that measures the year ones prices. So if we could some how multiply if we could multiply year 2's quantitiy by year 1's prices than we would get this rectangle right over here.
- And then the difference between that and year one would give us the incremental GDP in year one prices due to quantity and thats what we care about. We care about total productivity. We want to say how much more productive
- did the country get. so lets try to do it with these numbers. So we can figure out quantity in year two just by dividing the GDP by the price. Just by dividing this area of the entire blue rectangle and diving it by the price that would give us the quantity. If we divide 1200 by 55 cents,
- get my calculator out. So if I do 1200 divided by 55 cents this is my quantity of apples in pounds in year two. 2182, So this quantity is 2182 lbs in year 2. And then I could multiply this by the price. So this is the quantity and we could multiply it by the price in year one. So the price in year one is 50 cents a pound. So this will give me,
- 1091. And this is an interesting number. So you could do this as year two's GDP in year or ill write adjusted for price increases. or you could say in year one prices. And whats useful about this is this has look if prices had remained contstant
- this is what our GDP would have gotten too. If prices did not increased our GDP would have gotten to this 1091. 1091 is this area I drew in pink here. And so now if you could say prices were held constant, the growth in GDP would've been 91 dollars not 200 dollars.
- So this area right over here. The actual growth if prices were held constant would've been 91 dollars. We would've gone from 1000 in gdp to 1091 dollars. So this area right over here is 91 dollars. And we can call this area real growth.
- It really measures the productivity. Now this really gives an interesting, I guess set of ideas. One set of ideas is to measure GDP in the current years dollars. So this was measured in the year two dollars, year two prices. So we could call that year two's nominal GDP.
- Nominal gdp. Nominal in name. So its GDP in name. In that years prices, but this right over where we measured year two's GDP in some base years prices. So it allows a real comparison of how much our productivity actually increases.
- Our actual productivity actually produced at 9, 9 percent more apples. This we call real GDP. Real GDP, because it gives you a measure of real productivity. It tries to take out real price increase and we see in the future that
- in practice its kind of hard to really meausre what the absolute, this was a simple economy where we only had one product. But if we had many many many products actually gazillions of products in the real economy, prices are
- adjusting and the quantities are adjusting. It's not so easy to figure out how to adjust for price. But the folks running the national income accounts do try to do this so they get a sense of how much was the actual real growth.
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