In: Economics
2. Consider the following data for a hypothetical economy that produces two goods, milk and honey.
Quantity Produced |
Prices |
|||
Milk (litres) |
Honey (kg) |
Milk ($/litre) |
Honey ($/kg) |
|
Year 1 |
110 |
45 |
2 |
6 |
Year 2 |
125 |
40 |
3 |
7 |
Nominal GDP = Sum of price of current year * quantity of current year
Real GDP = Sum of price of base year * quantity of current year
GDP Deflator = Nominal GDP/Real GDP * 100
Growth in Real GDP = (Real GDP2 - Real GDP1) / Real GDP1 * 100
Now for Y1 (Y1 is base year)
Nominal GDP Y1 = 2*110+6*45=490
Real GDP Y1 = 2*110+6*45 = 490
GDP Deflator Y1 = 490/490 * 100 = 100
Now for Y2 (Y1 is base year)
Nominal GDP Y2 = 3*125+7*40=655
Real GDP Y2 = 2*125+6*40 = 490
GDP Deflator Y2= 655/490 * 100 = 133.67
Real GDP Growth = (490-490)/490 = 0, Hence NO GROWTH
Now considering Y2 as base year
Nominal GDP remains the same but Real GDP will change as the base year has changed
Real GDP Y1 = 3*110+7*45=645
Real GDP Y2 = 3*125+7*40 = 655
Deflator Y! = 490/645 * 100 = 75.98
Deflator Y2 = 655/655 * 100 =100
Real GDP depends upon choice of the base year and as stated above is calculated on the basis of prices of the goods in base year and quantity in current year. If you change base year, prices in calculation of real GDP will change and the value of final Real GDP will change.
As the growth of real GDP and deflator are dependent on Real GDP value therefore any change in base year will change these value too.