This document provides an overview of macroeconomic concepts including:
- Nominal GDP measures total output at current prices while real GDP accounts for inflation by using constant prices such as the GDP deflator or CPI.
- The GDP deflator is the ratio of nominal GDP to real GDP and measures inflation across all domestic goods and services.
- The CPI measures inflation based on consumer goods including imports and excludes investment and government goods.
- Potential GDP represents the maximum output of an economy without creating inflationary pressures from full employment of resources.
This document provides an overview of macroeconomic concepts including:
- Nominal GDP measures total output at current prices while real GDP accounts for inflation by using constant prices such as the GDP deflator or CPI.
- The GDP deflator is the ratio of nominal GDP to real GDP and measures inflation across all domestic goods and services.
- The CPI measures inflation based on consumer goods including imports and excludes investment and government goods.
- Potential GDP represents the maximum output of an economy without creating inflationary pressures from full employment of resources.
This document provides an overview of macroeconomic concepts including:
- Nominal GDP measures total output at current prices while real GDP accounts for inflation by using constant prices such as the GDP deflator or CPI.
- The GDP deflator is the ratio of nominal GDP to real GDP and measures inflation across all domestic goods and services.
- The CPI measures inflation based on consumer goods including imports and excludes investment and government goods.
- Potential GDP represents the maximum output of an economy without creating inflationary pressures from full employment of resources.
This document provides an overview of macroeconomic concepts including:
- Nominal GDP measures total output at current prices while real GDP accounts for inflation by using constant prices such as the GDP deflator or CPI.
- The GDP deflator is the ratio of nominal GDP to real GDP and measures inflation across all domestic goods and services.
- The CPI measures inflation based on consumer goods including imports and excludes investment and government goods.
- Potential GDP represents the maximum output of an economy without creating inflationary pressures from full employment of resources.
CPI, GDP Deflator Nominal Vs Real GDP Nominal GDP: values the production of goods and services at current prices. Real GDP: values the production of goods and services at constant prices. An accurate view of the economy requires adjusting nominal to real GDP by using a measure of inflation like the GDP deflator or the CPI. potential GDP: measures the maximum amount of economic output an economy can sustain at any moment without inducing any strains on production or unused resources. When an economy is operating at its potential, there are high levels of utilization of the labor force and capital stock. When output rises above potential, price inflation tends to rise, while a below potential level of output leads to high unemployment. Nominal to Real GDP • Converting Nominal GDP to Real GDP – Nominal GDP is converted to real GDP as follows:
Nominal GDP20XX Real GDP20XX 100 GDP deflator20XX Or CPI20xx GDP Deflator GDP Deflator is the ratio of the value of aggregate final output at current market prices (Nominal GDP) to its value at the base year prices (Real GDP). It is an adjustment for the impact of changes in prices on changes in nominal GDP. GDP Deflator can be considered the most comprehensive measure of inflation since a wide array of goods and services are included in its construction. But it may not reflect the full impact of inflation on consumer welfare because it does not include imported goods and services that constitute a significant portion of what people buy.
GDP Deflator = Nominal GDP/ Real GDP
Consumer Price Index
• The CPI expresses average prices each year
relative to a reference year, which is a CPI of 100. CPIt = (Prices in year t)/(Prices in reference year) x 100 Differences Between CPI & GDP Deflator
1)The first is that GDP Deflator includes only domestic
goods and not anything that is imported. On the other hand CPI includes anything bought by consumers including foreign goods. 2)The second difference is that the GDP Deflator is a measure of the prices of all goods and services while the CPI is a measure of only goods bought by consumers. Calculating GDP Deflator A Simple Economy • Suppose an economy produces three goods or services, Window Washing, Baseballs, and Hammers. Data for the past three years can be found below. Nominal GDP Step 1: Calculate Nominal GDP (The value of final goods and services evaluated at current- year prices) for each year: Nominal GDP 2006 NGDP2006 = Q2006 x P2006 = (90 x $50.00) Window Washing + (75 x $2.00) Baseballs + (50 x $30.00) Hammers = $6,150 Nominal GDP 2007 NGDP2007 = Q2007 x P2007 = (100 x $60.00) Window Washing + (100 x $2.00) Baseballs + (50 x $25.00) Hammers = $7,450
Nominal GDP 2008
NGDP2008 = Q2008 x P2008 = (100 x $65.00) Window Washing + (120 x $2.25) Baseballs + (65 x $25.00) Hammers= $8,395 Real GDP • Step 2: Calculate Real GDP (The value of final goods and services evaluated at base- year prices) for each year. For our example assume 2006 is the base year. This means that all values are in what we call “2006 Dollars”, or “Constant Dollars”. • By using the prices from the base-year, (or holding prices constant over time), we eliminate the impact that rising prices have on GDP, to get a measure of “Real” economic activity. Real GDP in 2006 RGDP2006 = Q2006 x P2006 = (90 x $50.00) Window Washing + (75 x $2.00) Baseballs + (50 x $30.00) Hammers = $6,150 Note: For the Base-Year Nominal GDP always equals Real GDP Real GDP in 2007 RGDP2007 = Q2007 x P2006 = (100 x $50.00) Window Washing + (100 x $2.00) Baseballs + (50 x $30.00) Hammers = $6,700 Real GDP in 2008 RGDP2008 = Q2008 x P2006 = (100 x $50.00) Window Washing + (120 x $2.00) Baseballs + (65 x $30.00) Hammers = $7,190 Note: We use “Current Quantities” and “Constant Prices”. Calculate the GDP Deflator NGDPt GDP _ Deflatort 100 RGDPt GDP Deflator for 2006 GDP Deflator2006 = (6,150/6,150) x 100 = 100 GDP Deflator for 2007 GDP Deflator2007 = (7,450/6,700) x 100 = 111.19 GDP Deflator for 2008 GDP Deflator2008 = (8,395/7,190) x 100 = 116.76
Note: The GDP Deflator is always equal to 100 in the
base-year. Calculating CPI For example, suppose our basket of goods consists of only three items: shirts, pants and bread with the following prices and quantities in 2006 and 2007:
Item Quantity Price in 2006 Price in 2007
Shirts 10 $10 $12
Pants 5 $20 $25
Bread 100 $0.50 $0.55
TOTAL Calculating CPI We're now going to calculate the Market Basket values for 2006 and 2007. Values that indicate Quantity will be in bold.
Market Basket for 2007 = (10* $12) + (5* $25) + (100* $0.55) = $120 + $125 + $55 = $300 Calculate CPI Expenditures _ in _ the _ Current _ Year CPI 100 Expenditures _ in _ the _ Base _ Year
Cost _ of _ Basket _ in _ Current _ Year
CPI 100 Cost _ of _ Basket _ in _ Base _ Year
CPI2006 = (250/250) x 100 = 100
CPI2007= (300/250) x 100 = 120
The value of the CPI is always equal to 100 in the base-year.
As with the GDP deflator, the CPI gives us an index number,
