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INTERPRTING REAL GDP What does the measurement of GDP tell us? GDP TELLS US The most important use of GDP is a measure of the size of the economy, providing us a scale against which to compare the economic performance of the years or other nations One must be careful when using GDP numbers, especially when making comparisons over time. Why? Because part of the increase in the value of GDP over time represents increases in the price of goods and services rather than an increase in output. To measure actual changes in aggregate output, we need a modified version of GDP that is adjusted for price changes (real GDP) REAL GDP: MEASURE OF AGGREGATE OUTPUT GDP number is an interesting and useful statistic, one that provides a good way to compare the size of different economies. Problem is it is not a good measure of the economy’s growth over time. Why? GDP can grow because the economy grows, but it can also grow because of inflation. Even if an economy’s output doesn’t change, GDP will go up if the prices of the goods and services the economy produces increase. GDP can fall because either the economy is producing less or because prices have fallen. To measure the economy’s growth with accuracy, we need a measure of aggregate output. Total quantity of final goods and services the economy produces which is real GDP. CALCULATING REAL GDP By tracking real GDP over time, we avoid the issue of changes in prices distorting the value of changes in production over time. To understand how real GDP is calculated we must look at data YEAR 1 YEAR 2 Apples (2,000 billion X $.25) + Oranges (1,000 billion X $.50)= 1,000 billion Apples (2,200 billion X $.30) + Oranges (1,200 billion X $.70) = 1,500 billon This is a 50% increase but is it really? This increase in the dollar value of GDP overstates the real growth in the economy. Yes the quantities of both apples and oranges increased from year one to year two so did the prices. Part of the that 50% growth is not higher production, the dollar value of GDP simply reflects higher prices. How do we measure the true increase in aggregate output produced? Find the value of output in year 2 expressed in year 1 prices. Apples (2,200 billion X $.25) + Oranges (1,200 billion X $.50) = 1,150 billion. Output in year 1 with year 1 prices was 1,000 billion so from year 1 to year 2 GDP measured in year 1 prices rose 15% from 1,000 billion to 1,150 billion Real GDP Is the total value of final goods and services produced in the economy during a year, calculated as if prices had stayed constant at the same level of some given base year. Nominal GDP Number that has not been adjusted for changes in prices is calculated using the prices in the year in which the output is produced. Real GDP number always come with info about what the base year is. GDP at current prices By using real GDP we do not overstate growth instead we are able to focus on changes in the quantity of output. WHAT REAL GDP DOESN’T MEASURE GDP is a measure of a nation’s aggregate output. Other things equal, a nation with a larger population will have higher GDP simply because they have more people working. If we want to compare nations and want to get rid of the population effect we use the measure GDP per capita Real GDP per capita can be a useful measure Comparison of labor productivity between nations. However, despite that fact that it is a rough measure of the average real output per person, real GDP per capita has limitations as a measure of a nations living standards.