Economic Growth Chapter Outcomes Differentiate between real and nominal variables calculate nominal GDP and real GDP Calculate the GDP deflator Calculate nominal wages and real wages Describe the production possibilities frontier implications for economic growth and its Measuring U S GDP Growth Nominal GDP and Real GDP Nominal GDP is the value of goods and services produced during a given year valued at the prices that prevailed in that same year Nominal GDP is just a more precise name for GDP Gross Domestic Product Nominal GDP GDP valued in current year s prices unadjusted for inflation sum of all monetary transactions involving final goods and services which occur in the economy in a year Measuring U S GDP Growth Nominal GDP and Real GDP Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year Currently the reference base year is 2012 and we describe real GDP as measured in 2012 dollars Real GDP Represents aggregate real income of a nation which is nominal income adjusted for inflation since base year used to measure real GDP Gross Domestic Product Real GDP GDP valued in constant prices base year adjusted for inflationary changes in price level allows production to be compared across time measuring real GDP helps evaluate economic performance Calculating Nominal G D P and Real G D P Measuring U S G D P Calculating Real G D P Table shows the quantities produced and the prices in 2012 the base year Nominal G D P in 2012 is 100 million Because 2012 is the base year real G D P equals nominal G D P and is 100 million Calculating Nominal G D P and Real G D P Measuring U S G D P Calculating Real G D P Table shows the quantities produced and the prices in 2021 Nominal G D P in 2021 is 300 million Nominal G D P in 2021 is three times its value in 2012 Calculating Nominal G D P and Real G D P Measuring U S G D P Calculating Real G D P In Table we calculate real G D P in 2021 The quantities are those of 2021 as in part b The prices are those in the base year 2012 as in part a The sum of these expenditures is real G D P in 2021 which equals 160 million The Uses and Limitations of Real GDP Economists use estimates of real GDP for two main purposes To compare the standard of living over time To compare the standard of living across countries Gross Domestic Product Potential GDP real GDP when all economy s resources are fully employed Economic growth is measured by sustained increase in potential GDP GDP Deflator Tells us rise in nominal GDP attributable to rise in prices rather than rise in quantities produced GDP Deflator A measure of the price level i e the average level of prices Is an average of current year prices expressed as a percentage of base year prices Comprehensive measure of the cost of real GDP basket of goods and services Measuring the Price Level Measuring the Price Level The GDP Deflator NOMINAL REAL GDP NOMINAL REAL GDP inflating for falling prices inflating for falling prices deflating for rising prices deflating for rising prices The Price Level The GDP Deflator Measures the average level of prices of all the goods and services that are included in GDP GDP deflator Nominal GDP Real GDP 100 Measuring the Price Level Measuring the Price Level The GDP Deflator GDP price index 2008 Price of market Price of 2008 market basket 2008 basket in the base year 2000 x 100 The Price Level and Inflation The GDP Deflator can now be calculated GDP deflator 146 109 5 100 133 33 Real GDP and the Price Level Deflating the GDP Balloon Nominal GDP increases because production real GDP increases Real GDP and the Price Level Deflating the GDP Balloon Nominal GDP also increases because prices rise Real GDP and the Price Level Deflating the GDP Balloon We use the GDP deflator to let the air out of the nominal GDP balloon and reveal real GDP Year Year 1 Year 2 Year 3 Price of A 10 12 14 Quanti ty of A 120 200 180 Price of B 12 15 18 Quanti ty of B 200 300 275 Nominal and Real GDP Nominal GDP in year 1 3600 10x120 12x200 Nominal GDP in year 2 6900 12x200 15x300 Nominal GDP in year 3 7470 14x180 18x275 Using year 1 as base year Real GDP in year 1 3600 Real GDP in year 2 5600 10x200 12x300 Real GDP in year 3 5100 10x180 12x275 GDP deflator for year 1 100 3600 3600 x 100 GDP deflator for year 2 123 21 6900 5600 x 100 GDP deflator for year 3 146 67 7470x5100 x 100 The Basics of Economic Growth Economic growth is the sustained expansion of production possibilities measured as the increase in real GDP over a given period Calculating Growth Rates The economic growth rate is the annual percentage change of real GDP The economic growth rate tells us how rapidly the total economy is expanding The Basics of Economic Growth The standard of living depends on real GDP per person population Real GDP per person is real GDP divided by the Real GDP per person grows only if real GDP grows faster than the population grows The Basics of Economic Growth The Magic of Sustained Growth The Rule of 70 states that the number of years it takes for the level of a variable to double is approximately 70 divided by the annual percentage growth rate of the variable The Basics of Economic Growth Applying the Rule of 70 Figure 6 1 show the doubling time for growth rates A variable that grows at 7 percent a year doubles in 10 years A variable that grows at 2 percent a year doubles in 35 years A variable that grows at 1 percent a year doubles in 70 years Long Term Growth Trends Long Term Growth in the U S Economy From 1901 to 2021 growth in real G D P per person in the United States averaged 2 percent a year Real G D P per person fell precipitously during the Great Depression and rose rapidly during World War Growth averaged 3 percent a year during the 1960s Growth picked up somewhat during the 1980s and even more during the dot com expansion of the 1990s but it never returned to the rate achieved during the 1960s The next slide illustrates Long Term Growth Trends How Potential GDP Grows Economic growth occurs when real GDP increases But a one shot increase in real GDP or a recovery from recession is not economic growth Economic growth is the sustained year on year increase in potential GDP The Uses and Limitations of Real G D P Two features of our expanding living standard are The growth of potential G D P per person Fluctuations of real G D P around potential G D P Potential G D …