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Free-response/problem Explain why an economy’s income must equal its expenditure. CHAPTER 23 MEASURING A NATION’S INCOME 0 23 Measuring a Nation’s Income PRINCIPLES OF ECONOMICS FOURTH EDITION N. G R E G O R Y M A N K I W PowerPoint® Slides by Ron Cronovich © 2007 Thomson South-Western, all rights reserved Real versus Nominal GDP Inflation can distort economic variables like GDP, so we have two versions of GDP: One is corrected for inflation, the other is not. Nominal GDP values output using current prices. It is not corrected for inflation. Real GDP values output using the prices of a base year. Real GDP is corrected for inflation. CHAPTER 23 MEASURING A NATION’S INCOME 2 EXAMPLE: Pizza Latte year P Q P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 Compute nominal GDP in each year: Increase: 2002: $10 x 400 + $2 x 1000 = $6,000 37.5% 2003: $11 x 500 + $2.50 x 1100 = $8,250 30.9% 2004: $12 x 600 + $3 x 1200 = $10,800 CHAPTER 23 MEASURING A NATION’S INCOME 3 EXAMPLE: Pizza Latte year P Q P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 Compute real GDP in each year, using 2002 as the base year: Increase: 2002: $10 x 400 + $2 x 1000 = $6,000 20.0% 2003: $10 x 500 + $2 x 1100 = $7,200 16.7% 2004: $10 x 600 + $2 x 1200 = $8,400 CHAPTER 23 MEASURING A NATION’S INCOME 4 EXAMPLE: Nominal Real year GDP GDP 2002 $6000 $6000 2003 $8250 $7200 2004 $10,800 $8400 In each year, nominal GDP is measured using the (then) current prices. real GDP is measured using constant prices from the base year (2002 in this example). CHAPTER 23 MEASURING A NATION’S INCOME 5 EXAMPLE: Nominal Real year GDP GDP 2002 $6000 $6000 37.5% 20.0% 2003 $8250 $7200 30.9% 16.7% 2004 $10,800 $8400 The change in nominal GDP reflects both prices and quantities. The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation. CHAPTER 23 MEASURING A NATION’S INCOME 6 Nominal and Real GDP in the U.S., 1965-2005 Billions $12,000 $10,000 Real GDP $8,000 (base year 2000) $6,000 $4,000 Nominal $2,000 GDP $0 1965 1970 1975 1980 1985 1990 1995 2000 2005 CHAPTER 23 MEASURING A NATION’S INCOME 7 The GDP Deflator The GDP deflator is a measure of the overall level of prices. Definition: nominal GDP GDP deflator = 100 x real GDP One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next. CHAPTER 23 MEASURING A NATION’S INCOME 8 EXAMPLE: Nominal Real GDP year GDP GDP Deflator 2002 $6000 $6000 100.0 14.6% 2003 $8250 $7200 114.6 2004 $10,800 $8400 128.6 12.2% Compute the GDP deflator in each year: 2002: 100 x (6000/6000) = 100.0 2003: 100 x (8250/7200) = 114.6 2004: 100 x (10,800/8400) = 128.6 CHAPTER 23 MEASURING A NATION’S INCOME 9 ACTIVE LEARNING 2: Computing GDP 2004 (base yr) 2005 2006 P Q P Q P Q good A $30 900 $31 1,000 $36 1050 good B $100 192 $102 200 $100 205 Use the above data to solve these problems: A. Compute nominal GDP in 2004. B. Compute real GDP i

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