Chapter 11, Problem 1FRQ

a)

To determine

The question requires us to determine nominal GDP in year 1.

Answer to Problem 1FRQ

The value of nominal GDP in year 1 is $10030.

Explanation of Solution

Real GDP is the value of GDP calculated at the base year prices. It is the inflation-adjusted value of all final goods and services in a given year in an economy.

The nominal GDP is calculated by using the current year's prices as it doesn’t adjust for inflation.

From the table:

The cost of a basket in year 1:

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantities }\times \text{ Current year prices}\right)}\\ =\left(\$900\times 10\right)+\left(\$10\times 100\right)+\left(\$15\times 2\right)\\ =\$9000+\$1000+\$30\\ =\$10,030\end{array}$

The value of nominal GDP in year 1 is $10,030.

b)

To determine

The question requires us to determine real GDP in year 1.

Answer to Problem 1FRQ

The value of real GDP in year 1 by using the prices of year 1 is $10,030.

Explanation of Solution

In the base year value of real GDP equals the value of nominal GDP because both estimations are using the base year quantity and base year prices.

So, the value of real GDP in year 1 by using the prices of year 1 is $10030.

The value of real GDP:

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantities }\times \text{ Current year prices}\right)}\\ =\left(\$900\times 10\right)+\left(\$10\times 100\right)+\left(\$15\times 2\right)\\ =\$9000+\$1000+\$30\\ =\$10,030\end{array}$

c)

To determine

The question requires us to determine real GDP in year 2.

Answer to Problem 1FRQ

The value of real GDP in year 2 using prices of the base year is $11,945.

Explanation of Solution

Real GDP is the value of GDP calculated at the base year prices. It is the inflation-adjusted value of all final goods and services in a given year in an economy.

The nominal GDP is calculated by using the current year's prices as it doesn’t adjust for inflation.

From the table:

The cost of the basket in year 2 (by using year 1 as the base year):

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantity }\times \text{ Base year prices}\right)}\\ =\left(\$900\times 12\right)+\left(\$10\times 110\right)+\left(\$15\times 3\right)\\ =\$10800+\$1100+\$45\\ =\$11,945\end{array}$

The value of real GDP in year 2 using prices of the base year is $11,945.