Activity'2:'Nominal'vs.'Real'GDP'-'Key'
When%comparing%GDP%over%time%it%is%important%to%adjust%for%inflation%by%examining%changes%in%Real'GDP.%
Why?%Nominal'(unadjusted)'GDP%measures%growth%in%economic%output%in%the%prices%at%which%they%are%
sold.%But%over%time%prices%rise,%so%an%increase%in%GDP%could%mean%that%output%has%increased,%prices%have%
increased,%or%some%combination%of%the%two.%To%determine%if%the%economy%has%grown,%prices%must%be%
held%constant.%%
To%see%the%difference,%imagine%a%small%country%that%produces%two%goods%–%burritos%and%haircuts.%%
%
In%year%1,%the%economy%produced:%
%
20%burritos%which%were%sold%for%$1%each%=%$20%
20%haircuts%which%were%sold%for%$4%each%=%$80%
%
The'GDP'in'year'1'was'$100%
%
In%year%2,%the%economy%produced:%
%
20%burritos%which%were%sold%for%$2%each%=%$%40%
30%haircuts%which%were%sold%for%$5%each%=%$150%
%
The'GDP'in'year'2'was'$190%
%
%
GDP%increased%from%$100%to%$190%in%one%year,%which%is%a%90%percent%increase!%This%is%an%increase%in%
Nominal'GDP.%But%did%the%economy%really%grow%by%90%percent%in%one%year?%Or%was%some%of%the%increase%
in%GDP%due%to%the%increase%in%price?%
To%find%out,%you%must%hold%the%price%constant.%You%can%do%this%by%using%the%prices%from%year%1%for%both%
calculations.%In%this%case,%year%2%looks%like%this:%
%
In%year%1,%the%economy%produced:%
%
20%burritos%which%were%sold%for%$1%each%=%$20%
20%haircuts%which%were%sold%for%$4%each%=%$80%
%
The'GDP'in'year'1'was'$100%
%
In%year%2,%the%economy%produced:%
%
20%burritos%which%were%sold%for%$1%each%=%$%20%
30%haircuts%which%were%sold%for%$4%each%=%$120%
%
The'GDP'in'year'2'was'$140%
%
%
