NOMINAL VERSUS REAL Nominal is the CURRENT value

NOMINAL VERSUS REAL Nominal is the CURRENT value of output in an economy. If I state that GDP is 17 trillion dollars this is a nominal figure as I am not comparing it to any other GDP figures or time. Because the dollar is used for measuring or valuing GDP and because the dollar changes in value over time, comparisons can be difficult to make.

MEASURING To make comparisons we have to have a measurement that doesn’t vary in value. So if we want to compare GDP now with GDP in the past we have to be able to adjust GDP in one place or the other for the changes in the value of the dollar. Real GDP is a figure that has been adjusted for the changes in value of the dollar.

WAYS TO MEASURE PRICE CHANGE 1) Establish a price index for the years in question. A price index is a measure of the price of a specific collection of goods and services, usually called a market basket, in a given year, that is compared to a similar if not identical collection of goods and services in a reference or base year

USING A PRICE INDEX TO MEASURE CHANGE Using a price index can allow us to divide the price of a market basket in a specific year by the price of a market basket in a base year and the multiply that result by 100.

WHAT GOES ON IN THE REAL WORLD Points to remember: Once we establish the price index and nominal GDP we can see clearly how Real GDP can be obtained. The base year is always calculated as 100 or 1 since real and nominal GDP in that year are equal. Real GDP allows us to see actual growth or shrinkage in the economy because we are using a “constant dollar” measuring stick.

CPI (CONSUMER PRICE INDEX) Measures the cost of a constant standard of living for a typical urban consumer. Generally, this fixed weight basket of items will remain the same over time. It is usually adjusted approximately once a decade. The current composition of goods was determined from survey of urban consumers in 2003 -2005.

CPI Although the CPI is not a GDP deflator, it can serve as a kind of guide to general changes in the value of the dollar over time. The GDP index is more sensitive because it changes components every year.

COMPONENTS OF THE CPI Major groups and examples of categories in each are as follows: FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks) HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture) APPAREL (men's shirts and sweaters, women's dresses, jewelry) TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services) RECREATION (televisions, toys, pets and pet products, sports equipment, admissions); EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories); OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

WHAT GDP DOESN’T MEASURE GDP only measures those things for which income is generated that are legal and reported. It also doesn’t measure some things that may add to the quality of life or subtract from it simply because they are generally not amenable to measurement.

GDP SHORTCOMINGS Cannot measure the value of things such as homemaker, volunteer work, home improvement) Doesn’t measure improvements in product quality or increased leisure time Doesn’t adjust for change in composition of output or distribution of income

SHORTCOMINGS Underground economy: Illegal activities are not counted Legal “untaxed” activities are not counted GDP and the environment: Harmful effects of pollution are not deducted from GDP Nor are costs associated with cleaning things up such as payments for oil spills etc

GDP FINALE Per capita GDP is a better, although, not perfect way to measure standards of living Non economic sources of well being such as courtesy, lack of crime, health, and happiness are not covered in GDP