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Chapter 2 Standard of Living

This document discusses measuring a nation's standard of living using GDP. It defines nominal GDP, which uses current prices, and real GDP, which uses prices from a base year to account for inflation. The example shows how to calculate nominal and real GDP for different years. It also introduces the GDP deflator, which measures the overall inflation rate. While real GDP per capita indicates average living standards, GDP is not a perfect measure of economic well-being.

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23 views12 pages

Chapter 2 Standard of Living

This document discusses measuring a nation's standard of living using GDP. It defines nominal GDP, which uses current prices, and real GDP, which uses prices from a base year to account for inflation. The example shows how to calculate nominal and real GDP for different years. It also introduces the GDP deflator, which measures the overall inflation rate. While real GDP per capita indicates average living standards, GDP is not a perfect measure of economic well-being.

Uploaded by

SARASVATHYDEVI SUBRAMANIAM
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER

2
Measuring Standard of Living

© 2009 South-Western, a part of Cengage Learning, 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.

MEASURING A NATION’S INCOME 2


EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10 400 $2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200

Compute nominal GDP in each year: Increase:


2005: $10 x 400 + $2 x 1000 = $6,000
37.5%
2006: $11 x 500 + $2.50 x 1100 = $8,250
30.9%
2007: $12 x 600 + $3 x 1200 = $10,800
MEASURING A NATION’S INCOME 3
EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10$10 400 $2.00
$2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200

Compute real GDP in each year,


using 2005 as the base year: Increase:
2005: $10 x 400 + $2 x 1000 = $6,000
20.0%
2006: $10 x 500 + $2 x 1100 = $7,200
16.7%
2007: $10 x 600 + $2 x 1200 = $8,400
MEASURING A NATION’S INCOME 4
EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
2006 $8250 $7200
2007 $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 (2005 in this example).
MEASURING A NATION’S INCOME 5
EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
37.5% 20.0%
2006 $8250 $7200
30.9% 16.7
2007 $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.
MEASURING A NATION’S INCOME 6
The GDP Deflator
 The GDP deflator is a measure of the overall
level of prices.
 Definition:
nominal GDP
GDP
GDP deflator 100 xx
deflator == 100
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.

MEASURING A NATION’S INCOME 7


EXAMPLE:
Nominal Real GDP
year GDP GDP Deflator
2005 $6000 $6000 100.0
14.6%
2006 $8250 $7200 114.6
2007 $10,800 $8400 12.2%
128.6

Compute the GDP deflator in each year:

2005: 100 x (6000/6000) = 100.0


2006: 100 x (8250/7200) = 114.6

2007: 100 x (10,800/8400) = 128.6

MEASURING A NATION’S INCOME 8


ACTIVE LEARNING 2
Computing GDP
2007 (base yr) 2008 2009
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 2007.
B. Compute real GDP in 2008.
C. Compute the GDP deflator in 2009.
9
ACTIVE LEARNING 2
Answers
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205

A. Compute nominal GDP in 2007.


$30 x 900 + $100 x 192 = $46,200

B. Compute real GDP in 2008.


$30 x 1000 + $100 x 200 = $50,000
10
ACTIVE LEARNING 2
Answers
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205
C. Compute the GDP deflator in 2009.
Nom GDP = $36 x 1050 + $100 x 205 = $58,300
Real GDP = $30 x 1050 + $100 x 205 = $52,000
GDP deflator = 100 x (Nom GDP)/(Real GDP)
= 100 x ($58,300)/($52,000) = 112.1
11
GDP and Economic Well-Being
 Real GDP per capita is the main indicator of
the average person’s standard of living.
 But GDP is not a perfect measure of
well-being.
 Robert Kennedy issued a very eloquent
yet harsh criticism of GDP:

MEASURING A NATION’S INCOME 12

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