Real GDP and nominal GDP

let's say we're studying a very small and oversimplified country that only sells only sells apples and we measure the GDP in year one in GDP in year one and we measure that GDP as a thousand dollars and all of that is due to apples and we also know that the price of apples in year one was were fifty cents a pound so I'll write it as fifty 50 cents per pound and let's say that we are now a year one has gone by and even year two has gone by and we're able to measure the GDP in year two so GDP in year two is twelve hundred dollars and the price of apples in year two let's just say it is fifty five cents a pound fifty fifty five cents a pound fifty five cents a pound so my question to you is GDP the whole point of measuring GDP is measuring the productivity of a country I mean we're measuring in terms of dollars but we care more about just the dollar amount we really cares 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 thousand dollars versus is twelve hundred it gives you the sense that well at least if you just look at the numbers 1200 is 20% larger than one thousand dollars so if you just look at those numbers right over there it looks like the GDP grew by 20 percent but 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 because 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 let me draw a little diagram on this axis I'll do quantity on this axis I will do price and P one so if I want to figure out the GDP and 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 and then this right over here the area of this green rectangle would be GDP and year one GDP in year one and then GDP in year two would be the price in year two so we're going to go from fifty cents to fifty-five cents the price in year 2 times the quantity in year two we'll assume some growth has occurred times the quantity in year two and so GDP in year two would be this in the area of this entire rectangle and if we want to find the difference between GDP in year two and GDP in year one it would be the difference in area so 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 and year 2 and GDP and year 1 the area I'm shading in blue would be would be this 200 the 200 increment that would be that so this area right over here would be that 200 now when you look at it 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 a lot of it is also due to an increase in price so if we really wanted to figure out how much more productive the quantity country got and we still want to measure GDP in dollars maybe we can take a measure of GDP that measures year 2's GDP but it does it in year ones prices so if we could somehow multiply if we could multiply year twos quantity by year ones prices then we would get this rectangle right over here 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 that's what we care about we care about total productivity when we're thinking about GB you want to say how much more productive the country get so let's try to do it with these numbers with these numbers right over here so we can figure out quantity 2 we could figure out the quantity in year 2 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'll give us the quantity so if we divide 12 hundred divided by 55 cents let me get my calculator out so if I do if I do 12 100 divided by 55 cents this is my quantity of apples and in pounds in year two and I'll just round it 2182 so this is 2182 so the quantity in year two is twenty 182 pounds 20 182 pounds and then I could so this is equal to that and then I could multiply this times the price so this is this quantities two thousand one hundred eighty two pounds and then I could multiply it times the price in year one a year once price I'm going to multiply it times p1 is equal to 50 cents a pound fifty cents per pound and 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 Oh point five and I get 1090 I'll just say ten I'll round it to ten ninety one so this is equal to ten ninety one and this is an interesting number so this is you could view this as year year twos GDP G GDP in year or adjusted for alright adjusted for adjusted for prices or adjusted for price increases or you could say in year one prices in year one prices and what's useful about this is this says look if prices had remained constant this is how what our GDP would have gotten to if prices did not increase our GDP would have gotten to this 1091 1091 is this area that I drew in pink here and so now you could say if prices were held constant the growth in GDP the growth in GDP would have been ninety one dollars not two hundred dollars so this pink 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 would have gone from one thousand dollars of GDP to one thousand ninety one dollars so this right over here that area is ninety one dollars of and we could even call it real growth real growth it really measures the productivity now this gives us an interesting I guess set of ideas one idea is to just measure your GDP in the current year's dollars so this was GDP measured in year two dollars it was year two GDP measured in year two dollars year two prices so we could call that year 2's nominal GDP nominal GDP nominal and name so its GDP and named in that year's prices but this right over here where we measured year twos GDP in some base year's prices so it allows a real comparison of how much that our productivity actually increase our productivity actually increased by nine percent we produced nine percent more apples this week all real GDP real real GDP because it gives you a measure of real productivity it tries to take out price increases but we'll see in the future or we might not do it an introductory course but in practice it's kind of hard to really measure what the absolute you know if you wait everyday this was a simple economy where we only had we really only had one product but if you have many many many products act you know 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 but the 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