Question

5. Real versus nominal GDP

Consider a simple economy that produces two goods: pencils and oranges. The following table shows the prices and quantities of the goods over a three-year period.

Year	Pencils		Oranges
	Price	Quantity	Price	Quantity
	(Dollars per pencil)	(Number of pencils)	(Dollars per orange)	(Number of oranges)
2018	2	115	5	175
2019	4	150	2	180
2020	1	100	2	160

Use the information from the preceding table to fill in the following table.

Year	Nominal GDP	Real GDP	GDP Deflator
	(Dollars)	(Base year 2018, dollars)
2018
2019
2020

From 2019 to 2020, nominal GDP (Decreased/Increased), and real GDP(Decreased/Increased) .

The inflation rate in 2020 was (-47.5%, -0.5%, 47.5%, 52.5%, 190.5%) .

Why is real GDP a more accurate measure of an economy's production than nominal GDP?

- Real GDP does not include the value of intermediate goods and services, but nominal GDP does.

- Real GDP measures the value of the goods and services an economy produces, but nominal GDP measures the value of the goods and services an economy consumes.

-Real GDP is not influenced by price changes, but nominal GDP is.

Answer 1

Nominal GDP in 2018 = 2*115 + 5*175 = $1105

Real GDP in 2018 = 2*115 + 5*175 = $1105

In 2018, the nominal GDP is equal to the real GDP because 2018 is a base year.

GDP deflator = Nominal GDP/ Real GDP * 100

= ($1105 / $1105 )*100

= 100

Nominal GDP in 2019 = 4*150 + 2*180 = $960

Real GDP in 2019 = 150*2 + 180*5 = $1200

GDP deflator in 2019 = ($960/$1200)*100 = 80

Nominal GDP in 2020 = 1*100 + 2*160 = $420

Real GDP in 2020 = 2*100 + 5*160 = $1000

GDP deflator in 2020 = (420/1000)*100 = 42.

So, we can see that from 2019 to 2020, nominal GDP decreased and teal GDP also decreased.

Inflation rate in 2020 = Cost of basket of goods in 2019 with 2020’s prices / Cost of basket of goods in 2019 with 2019’s prices

= (((150*1 + 2*180) / (150*4 + 180*2))*100) - 100

= (($510 / $ 960)*100) - 100

= 53.125 - 100

= -46.875%

So, we can say that the inflation rate has is around -47.5%. As the total expenditure has decreased due to reduced prices, we have a negative value of inflation.

Real GDP is a more accurate measure of an economic production than nominal GDP because real GDP is not influenced by price changes, but nominal GDP is. Nominal GDP takes the quantities of the base year whereas, the real GDP takes the quantities of the base year. So option 3 is the correct answer.

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