Econ 102 Discussion Section 4 (Chapter 8, 10.

1 and 11) February 6, 2015

Real vs. Nominal GDP

Nominal GDP is defined as GDP that has not been adjusted for prices and has been calculated using
the prices in the year in which the output is produced.
Real GDP is GDP calculated as if prices had remained at the level of some given base year.
There are two methods to solve problems involving real/nominal GDP. One involves using the price-
quantity method and the other involves a new formula comparing real/nominal GDP

Revisiting the Quantity Method

! !"##$%&  !"#$ ! !"#$  !"#$
𝑁𝑜𝑚𝑖𝑛𝑎𝑙  𝐺𝐷𝑃 =   !!! 𝑃! 𝑄! 𝑅𝑒𝑎𝑙  𝐺𝐷𝑃 =   !!! 𝑃! 𝑄!

Example 1: An economy produces two goods: hot dogs and burgers.

In 2014, 15 hot dogs are produced at a price of $2 each, and 20 burgers at a price of $7 each.
In 2015, 20 hot dogs are produced at a price of $4 each, and 30 burgers at a price of $8 each.
Find the following:
Nominal GDP of 2014:
(15 x 2) + (20 x 7) = 170
Nominal GDP of 2015:
(20 x 4) + (30 x 8) = 320
Real GDP of 2014 using 2014 as base year:
170
Real GDP of 2015 using 2014 as base year:
(20 x 2) + (30 x 7) = 250

The GDP Deflator

𝑁𝑜𝑚𝑖𝑛𝑎𝑙  𝐺𝐷𝑃
𝐺𝐷𝑃  𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 =   ×100
𝑅𝑒𝑎𝑙  𝐺𝐷𝑃
The GDP Deflator is an index number. It is a data point reflecting the price level compared to some
base level, which is almost always 100. Note that the GDP Deflator can be used to find the inflation
rate over two years.

Example 2: Using the information from Example 1, and assuming that 2014 is the base year,
calculate the GDP Deflator in 2014 and 2015 along with the inflation rate between the two years.

GDP Deflator 2014 = 100 GDP Deflator 2015 = (320 / 250) x 100 = 128
Inflation Rate between 2014 and 2015 = 28%

Other Measure of Total Production and Income

Gross National Product: GNP = GDP + Net Factor Income Earned from Abroad
Net National Product: NNP = GNP – Depreciation
National Income: NI = NNP – Indirect Business Taxes
Personal Income: PI = NI – Corporate Taxes + Transfer Payments
Disposable Personal Income: DPI = PI – Personal Income Taxes

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Econ 102 Discussion Section 4 (Chapter 8, 10.1 and 11) February 6, 2015

Long Run Economic Growth and Calculating Growth Rates

Real GDP per capita is the key statistic used to track economic growth
𝑅𝑒𝑎𝑙  𝐺𝐷𝑃
𝑅𝑒𝑎𝑙  𝐺𝐷𝑃  𝑝𝑒𝑟  𝑐𝑎𝑝𝑖𝑡𝑎 =  
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
For a single year, the economic growth rate is determined by the percent change in Real GDP per
capita from the beginning of the year to the end of the year. When we are dealing with multiple
years, we are often also concerned about the average annual economic growth rate, which is the
average of the economic growth rate over multiple years

Over longer periods of time, the relationship between the annual growth rate of real GDP per capita
and long run changes in real GDP per capita can be summarized using the rule of 70, which tells us
how long it takes any variable that grows over time to double:
70
𝑁𝑢𝑚𝑏𝑒𝑟  𝑜𝑓  𝑦𝑒𝑎𝑟𝑠  𝑓𝑜𝑟  𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒  𝑡𝑜  𝑑𝑜𝑢𝑏𝑙𝑒 =  
𝐺𝑟𝑜𝑤𝑡ℎ  𝑟𝑎𝑡𝑒  𝑜𝑓  𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒
Another useful concept to be mindful of is compounding. Typically thought of in the context of
interest rates, compounding illustrates how small changes in growth rates can lead to large
differences in the interest earned on an asset or in the real GDP per capita between two countries.

Example 3: Suppose that the real GDP per capita in the US is currently $8 million, and in Ghana it is
$2 million. Furthermore assume that the US economy is growing at 7% per year while Ghana is
growing at 14% per year. How long will it take for Ghana’s GDP to catch up with the United States?

When discussing long run economic growth, economists often refer to potential GDP. Potential GDP
is the level of real GDP produced when firms are producing at capacity. Note however the producing
at capacity does not mean producing the maximum amount of goods possible. Rather, capacity is
defined as the point where firms are operating at normal hours, with a normal sized workforce (i.e.
unemployment neither too high nor too low).
Long run growth is dependent on increases in labor productivity. This can be obtained in one of two
ways: increases in capital per hour worked or technological change. Increasing the capital per hour
worked could for instance mean increasing the number of ovens available per chef in a bakery, while
technological change could possibly mean improving the baking speed of said ovens

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Econ 102 Discussion Section 4 (Chapter 8, 10.1 and 11) February 6, 2015

Practice Problems
0. An economy produces two goods: tomatoes and ketchup. It is assumed that half of the tomatoes
are bought and consumed as final good, the other half is used to produce ketchup.
In 2014, 30 lbs. of tomatoes are produced at $2 each, and 20 oz. of ketchup at $7 each.
In 2015, 40 lbs. of tomatoes are produced at $4 each, and 30 oz. of ketchup at $8 each.
Find the following:
Nominal GDP of 2014: Nominal GDP of 2015:
(15 x 2) + (20 x 7) = 170 (20 x 4) + (30 x 8) = 320
Real GDP of 2014 using 2014 as base year: Real GDP of 2015 using 2014 as base year:
170 (20 x 2) + (30 x 7) = 250
Inflation Rate between 2014 and 2015
28%

1. Suppose that nominal per capita GDP was $40,000 in 2000 and $60,000 in 2007. If the GDP deflator
was 100 in 2000 and 150 in 2007, indicate the 2007 per capita real GDP measured in 2000 dollars.
a) $32,000 b) $38,000 c) $40,000 d) $42,500

2. According to the following table, what is the GDP deflator in 2005?

2004 2005
Nominal GDP $10,000 $12,000
Real GDP $8,000 $10,000
a) 125 b) 120 c) 87 d) 105

3. To examine how the production of goods has changed over time, it would be better to consider:
a) nominal GDP b) GDP at current prices
c) real GDP d) the GDP deflator

4. If real GDP rises while nominal GDP falls, the prices on average have:
a) fallen b) risen
c) stayed the same d) Real GDP cannot rise when nominal GDP falls

5. If nominal GDP exceeds real GDP for a specific year, then the GDP deflator must be:
a) less than zero b) less than 100 c) greater than 100 d) equal to 100

6. If the quantity of goods and services produced in the economy decreases,

a) real GDP would certainly increase
b) it may be possible for real GDP to increase
c) nominal GDP would certainly increase
d) it may be possible for nominal GDP to increase

7. If the amount of transfers from government to household increases given the same level of GDP,
this would _______.
a) increase GNP b) increase PI
c) increase DPI d) No effects on any measures of income

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Econ 102 Discussion Section 4 (Chapter 8, 10.1 and 11) February 6, 2015

Use the following information to answer the next four questions

“Birch from Brazilian forests is used by a U.S.-owned company located in Canada to produce
snowboard. Snowboard is sold in the U.S. The workers working in this factory is Mexican.”
(True / False) Birch wood exported is recorded in Brazil’s GDP
(True / False) Snowboard is counted as final good in Canada’s GDP
(True / False) Mexican workers in this factory contributes to Mexico’s GDP
(True / False) This transaction contributes zero to U.S.’s GDP

8. In 1990 real GDP per capita in the US was $40000. In 2004 real GDP per capita was $80000.
What was the average annual growth rate of real GDP per capita in the US during this time?
a) 100% b) 5% c) 10% d) 7.1%

9. If you put your $100 into a saving account which earns 5% interest, how long does it take for your
money to double? 14 years

10. If an economy is growing at 6% a year while the population is growing at 3% a year, what is true
about this economy?
a) The standard of living is rising b) The standard of living is falling
c) The standard of living is not changing d) Indeterminate

Use the following table to answer the next two questions

Bank Interest in 2013 Interest in 2014 Interest in 2015
US Bank 5% 5% 5%
UW Credit Union 2% 4% 8%

11. Suppose you have $100 to invest. Which bank would provide the most interest at the end of the
three years?
a) US Bank b) UW Credit Union c) They provide the same interest

12. Which concept does previous question best illustrate?

a) Rule of 70 b) Real vs Nominal GDP
c) Compounding d) Inflation

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