Calculating GDPCalculating GDP

Nominal GDP, Real GDP, and Nominal GDP, Real GDP, and the GDP Deflatorthe GDP Deflator

There are two ways that GDP There are two ways that GDP can increase:can increase:

1.1. An increase in the An increase in the PRICESPRICES of goods of goods and services.and services.

2.2. An increase in the An increase in the QUANTITYQUANTITY of of goods and services.goods and services.

We need a method to calculate GDP We need a method to calculate GDP that addresses rising pricesthat addresses rising prices

Our Simple EconomyOur Simple Economy

Suppose an economy produces three Suppose an economy produces three goods or services, Window Washing, goods or services, Window Washing, Baseballs, and Hammers. Data for Baseballs, and Hammers. Data for the past three years can be found the past three years can be found below.below.

Prices and Quantities for our Prices and Quantities for our Simple EconomySimple Economy

Nominal GDPNominal GDP

Step 1: Calculate Step 1: Calculate Nominal GDPNominal GDP ( (The value The value of final goods and services evaluated at of final goods and services evaluated at current-year pricescurrent-year prices) for each year:) for each year:

NGDPNGDP20062006 = Q = Q20062006 x P x P20062006 = (90 x $50.00) Window Washing= (90 x $50.00) Window Washing

+ (75 x $2.00) Baseballs+ (75 x $2.00) Baseballs+ (50 x $30.00) Hammers+ (50 x $30.00) Hammers

= $6,150= $6,150

Nominal GDP 2007Nominal GDP 2007

NGDPNGDP20072007 = Q = Q20072007 x P x P20072007

= (100 x $60.00) Window Washing= (100 x $60.00) Window Washing

+ (100 x $2.00) Baseballs+ (100 x $2.00) Baseballs

+ (50 x $25.00) Hammers+ (50 x $25.00) Hammers

= $7,450= $7,450

Nominal GDP 2008Nominal GDP 2008

NGDPNGDP20082008 = Q = Q20082008 x P x P20082008

= (100 x $65.00) Window Washing= (100 x $65.00) Window Washing

+ (120 x $2.25) Baseballs+ (120 x $2.25) Baseballs

+ (65 x $25.00) Hammers+ (65 x $25.00) Hammers

= $8,395= $8,395

Real GDPReal GDP

Step 2: Calculate Step 2: Calculate Real GDPReal GDP ( (The The value of final goods and services value of final goods and services evaluated at base-year pricesevaluated at base-year prices) for ) for each year. For our example assume each year. For our example assume 2006 is the base year. 2006 is the base year. This means This means that all values are in what we call that all values are in what we call “2006 Dollars”, or “Constant “2006 Dollars”, or “Constant Dollars”.Dollars”.

Real GDPReal GDP

By using the prices from the base-By using the prices from the base-year, (or holding prices constant over year, (or holding prices constant over time), we eliminate the impact that time), we eliminate the impact that rising prices have on GDP, to get a rising prices have on GDP, to get a measure of “Real” economic activity.measure of “Real” economic activity.

Real GDP in 2006Real GDP in 2006

RGDPRGDP20062006 = Q = Q20062006 x P x P2006 2006

= (90 x $50.00) Window Washing= (90 x $50.00) Window Washing

+ (75 x $2.00) Baseballs+ (75 x $2.00) Baseballs

+ (50 x $30.00) Hammers+ (50 x $30.00) Hammers

= $6,150= $6,150

Note: For the Base-Year Nominal GDP Note: For the Base-Year Nominal GDP always equals Real GDPalways equals Real GDP

Real GDP in 2007Real GDP in 2007

RGDPRGDP20072007 = Q = Q20072007 x P x P2006 2006

= (100 x $50.00) Window Washing= (100 x $50.00) Window Washing

+ (100 x $2.00) Baseballs+ (100 x $2.00) Baseballs

+ (50 x $30.00) Hammers+ (50 x $30.00) Hammers

= $6,700= $6,700

Note: We use “Current Quantities” and Note: We use “Current Quantities” and “Constant Prices”.“Constant Prices”.

Real GDP in 2008Real GDP in 2008

RGDPRGDP20082008 = Q = Q20082008 x P x P2006 2006

= (100 x $50.00) Window Washing= (100 x $50.00) Window Washing

+ (120 x $2.00) Baseballs+ (120 x $2.00) Baseballs

+ (65 x $30.00) Hammers+ (65 x $30.00) Hammers

= $7,190= $7,190

Note: We still use “Current Quantities” and Note: We still use “Current Quantities” and “Constant Prices”.“Constant Prices”.

The General Formula for The General Formula for Calculating a Growth RateCalculating a Growth Rate

100_

__%_

ValueOld

ValueOldValueNewChangePercent

100%_1

1

t

tt

X

XXChangePercent

Calculate the Growth Rate in Calculate the Growth Rate in Real GDP between 2006 and Real GDP between 2006 and

20072007%Change = [(RGDP%Change = [(RGDP20072007 – RGDP – RGDP20062006)/RGDP)/RGDP20062006] x 100] x 100

%Change = [(6,700 – 6,150)/6,150] x 100%Change = [(6,700 – 6,150)/6,150] x 100

%Change = 8.94%%Change = 8.94%

That is real GDP grew by 8.94% between 2006 and That is real GDP grew by 8.94% between 2006 and 2007. 2007.

Calculate the Growth Rate in Calculate the Growth Rate in Real GDP between 2007 and Real GDP between 2007 and

20082008%Change = [(RGDP%Change = [(RGDP20082008 – RGDP – RGDP20072007)/RGDP)/RGDP20072007] x 100] x 100

%Change = [(7,190 – 6,700)/6,700] x 100%Change = [(7,190 – 6,700)/6,700] x 100

%Change = 7.31%%Change = 7.31%

That is real GDP grew by 7.31% between 2007 and That is real GDP grew by 7.31% between 2007 and 2008.2008.

The Price LevelThe Price Level

We can use our calculations of We can use our calculations of Nominal GDPNominal GDP and and Real GDPReal GDP to to calculate the calculate the Price LevelPrice Level ( (A measure A measure of the average prices of goods and of the average prices of goods and services in the economy.services in the economy.))

The GDP DeflatorThe GDP Deflator

One example of a measure of the One example of a measure of the average average price levelprice level is the is the GDP GDP deflatordeflator. .

100_ t

tt RGDP

NGDPDeflatorGDP

Calculate the GDP Deflator for Calculate the GDP Deflator for 20062006

GDP DeflatorGDP Deflator20062006 = (NGDP = (NGDP20062006/RGDP/RGDP20062006) x 100) x 100

GDP DeflatorGDP Deflator20062006 = (6,150/6,150) x 100 = 100 = (6,150/6,150) x 100 = 100

Note: The GDP Deflator is always equal to Note: The GDP Deflator is always equal to 100 in the base-year.100 in the base-year.

The Price Index is “unitless”The Price Index is “unitless”

Calculate the GDP Deflator for Calculate the GDP Deflator for 2007 and 20082007 and 2008

GDP DeflatorGDP Deflator20072007 = (NGDP = (NGDP20072007/RGDP/RGDP20072007) x 100) x 100

GDP DeflatorGDP Deflator20072007 = (7,450/6,700) x 100 = = (7,450/6,700) x 100 = 111.19111.19

GDP DeflatorGDP Deflator20082008 = (NGDP = (NGDP20082008/RGDP/RGDP20082008) x 100) x 100

GDP DeflatorGDP Deflator20082008 = (8,395/7,190) x 100 = = (8,395/7,190) x 100 = 116.76116.76

The Inflation RateThe Inflation Rate

We can use the growth rate formula We can use the growth rate formula from previous to calculate the from previous to calculate the Inflation RateInflation Rate (the Inflation Rate is (the Inflation Rate is The percentage increase in the price The percentage increase in the price level from one year to the nextlevel from one year to the next.) .)

Calculate the Inflation Rate Calculate the Inflation Rate from 2006 to 2007from 2006 to 2007

Inflation Rate Between 2006 and 2007 = Inflation Rate Between 2006 and 2007 = [(GDP Def.[(GDP Def.20072007 – GDP Def. – GDP Def.20062006)/GDP Def.)/GDP Def.20062006] x ] x

100100

Inflation Rate Between 2006 and 2007Inflation Rate Between 2006 and 2007 = =

[(111.19 – 100)/100] x 100 = 11.19[(111.19 – 100)/100] x 100 = 11.19

That is the inflation rate between 2006 and That is the inflation rate between 2006 and 2007 was 11.19%.2007 was 11.19%.

Calculate the Inflation Rate Calculate the Inflation Rate from 2007 to 2008from 2007 to 2008

Inflation Rate Between 2007 and 2008 = Inflation Rate Between 2007 and 2008 = [(GDP Def.[(GDP Def.20082008 – GDP Def. – GDP Def.20072007)/GDP Def.)/GDP Def.20072007] x ] x

100100

Inflation Rate Between 2007 and 2008Inflation Rate Between 2007 and 2008 = =

[(116.76 – 111.19)/111.19] x 100 = 5.01[(116.76 – 111.19)/111.19] x 100 = 5.01

That is the inflation rate between 2007 and That is the inflation rate between 2007 and 2008 was 5.01%.2008 was 5.01%.

Nominal GDP in the U.S. Nominal GDP in the U.S. 1947 to 20081947 to 2008

Real GDP in the U.S. 1929 to Real GDP in the U.S. 1929 to 20082008