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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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