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Video transcript

in the last video we studied a super simplified economy that only sold one good or service but now let's think about things a little bit more generally or a little bit more of you know more complex economies and let's say that in year one in year one economists have determined that the level of prices of the goods and services produced in that economy is a hundred so they've they've essentially just you know they've multiplied and divided by the right numbers so that their index that they generate just says that that is 100 and they do this so that they can measure the prices in other years relative to year one so let's say in year two year to year two using their index they realize that prices are now 110 now this is not a simple thing to do this would have been a very simple thing to do if there is only one good or service in the economy like in our last example apples you could have just taken the price of apples that went from 50 cents to 55 cents in the real world this is not a simple thing to do you have a gazillion goods and services some prices go up some prices to go down the quantities of the goods and services change in fact there might there might be goods and services that were offered in year one that don't exist anymore near two and there are their goods and services in year two that didn't exist in year one but for the sake of this video let's just assume that economists are able to say this if you call the general level of prices a hundred and year one it's now a hundred and ten or another way to think about it is things have gotten ten percent more expensive now if we assuming that we have we know this relationship and once again it's not an easy thing to figure out and it actually turns out there's no perfect way to do this how can we figure out a relationship between real GDP and nominal GDP and remember whenever we talk about real GDP so we're going to talk about real GDP and year two so real GDP in year two whenever you talk about real GDP you're talking about GDP in terms of the prices in some base year so in this example we'll think about real GDP and year two in terms of year one dollars so whatever was whatever that were the goods and services that were produced in year two we're going to think about well what if they were at the same prices as in year one and that will give us the real GDP in year two so one way to think about it is really just a ratio so the ratio so let me write nominal GDP so this is GDP in year two measured in year two dollars divided by divided by Argos we could call this a proportion really divided by the real GDP in year two and this is measured in year one dollars measured in year one dollars well that's going to be the same thing as the ratio of the prices between year two and year one this is going to be the ratio of we use this indicator right over here 110 - 100 110 to 130 DP is measuring them in year one prices the nominal GDP is measuring them in year two prices so if things got 10 percent more expensive between year 1 and year 2 the nominal GDP should be 10 percent larger than real GDP we should have the exact same ratios and now we can manipulate this thing using any type of algebra that we want for example we could say we could say well nominal GDP and I'll just write nominal now but this is where I kind of specified exactly what we're talking about this is the nominal GDP of year 2 so now we could say nominal nominal GDP is equal to we can multiply both sides times the real GDP is equal to 110 over 100 over 100 times the real GDP times the real GB where real GDP and remember this is nominal GDP and year - this is real GDP and year two measured in year $1 or we can measure we can divide we could divide both sides of this equation by this 110 over 100 and then we get nominal nominal GDP and year 2 divided by / 110 over a hundred / 110 over a hundred is equal to real GDP is equal to real GDP real GDP and year - this is nominal GDP in your - I want Q I'll write nominal GDP and year - and writing it this way it kind of feels like you're taking your nominal GDP and year - and prices have increased it there's been a general increase in the level of prices that's called price inflation we see that right over here and now we're deflating it to get real GDP we're dividing it by the ratio of the prices we're dividing it essentially by how much the prices have grown or I guess you could say the ratio between the year two prices in the year one prices so this quantity right over here is one point one so another way you could think what we're deflating the nominal GDP in year two to get the real GDP in year two we're getting it in remember this is in year one prices year one prices and because of that this number right over here this number right over here is referred to as a deflator this is our GDP GDP deflator you pick a base here you pick a base here in this case it was year one that base year could have been 1985 it could have been 2006 who knows what it could be it could be anything your gdp deflator is going to be relative to that base year it's going to say well if that base year was 100 your deflator is going to say how much things are now in that this year and you can even go backwards in time Year Zero the deflator might have been 85 because maybe things have gotten cheaper or you could have actually had prices go down you could have actually had deflation so maybe in year two you're deflator would be at 98 but the reason why it's called a deflator is because generally you have inflation as time goes on and generally you're going to be deflating your nominal GDP you're going to be dividing it by a value greater than one it's going to be something over 100 divided by a hundred which is your base here to get your real GDP