Question

1.a) With reference to the circular flow of income diagram, describe the three ways in which a country’s GDP can be measured. Explain the difference between real and nominal GDP

There are 14 marks available for this part: 2 for correct diagram, 9 for descriptions of measuring GDP, 3 for the difference

.b) Money (nominal) income rises from £20m to £24m over a period of time Over the same period the general price level rises by 15%.

There are 4 marks available for this part: 2 for each calculation

i) Calculate the % rise in nominal income

ii) What is the % rise in real income?

Answer 1

1.

A) The circular flow of income diagram is represented as below:

It helps explain the three ways one can measure GDP:

1. Value added approach (it measures the value added to the good at each step of production)

2. Income approach (income earned by resources in the resource market)

3. Expenditure approach (expenditure made to produce the final goods and services)

B) Nominal GDP refers to the market value of all final goods and services produced in an economy in a given financial year.

Real GDP is nothing but inflation adjusted nominal GDP.

It measures the value of final goods and services produced in an economy at base year prices, rather than current year prices.

Numerically,

Real GDP = Nominal GDP / GDP deflator

2.

A) % change in nominal income = (24-20)/20 = 0.2 or 20%

B) % change in real income = % change in nominal income - % change in price level

% change in real income = 20% - 15%

% change in real income = 5%