Chapter 5, Problem 5PA

Sub part (a):

To determine

The nominal and real GDP and GDP deflator.

Explanation of Solution

The GDP is the summation of the monetary value of all the goods and services produced within the political boundary of a country, within a financial year. There are two different ways of calculating the GDP of the economy and they are the real GDP and the nominal GDP. The real GDP is the GDP calculated at the constant prices. There will be a base price index and the value of goods and services will be calculated on the basis of the constant prices. Thus, it will measure the GDP of the economy on the same base year price index, which will help us to identify the inflation in the economy. The nominal GDP is the GDP calculated at the current prices. The GDP will be calculated by multiplying the quantity of goods and services produced with the current year’s market prices which will include the inflation impact.

The nominal GDP of the economy can be calculated by multiplying the quantity produced by the per unit price of the commodity. The quantity produced and price in 2016 was 100 quarts of milk and 50 quarts of honey. The prices were $1 and $2 respectively, for each quart. Thus, the nominal GDP of 2016 can be calculated as follows:

$\begin{array}{c}{\text{Nominal GDP}}_{2016}=\left[\begin{array}{l}{\left({\text{Quantity produced}}_{2016}\times {\text{per unit price}}_{2016}\right)}_{\text{Milk}}\\ +{\left({\text{Quantity produced}}_{2016}\times {\text{per unit price}}_{2016}\right)}_{\text{Honey}}\end{array}\right]\\ =\left(100\times 1\right)+\left(50\times 2\right)\\ =100+100\\ =200\end{array}$

Thus, the nominal GDP of 2016 is $200.

Similarly, the quantity produced and price in 2017 was 200 quarts of milk and 100 quarts of honey. The prices were $1 and $2, respectively. Thus, the nominal GDP of 2017 can be calculated as follows:

$\begin{array}{c}{\text{Nominal GDP}}_{2017}=\left[\begin{array}{l}{\left({\text{Quantity produced}}_{2017}\times {\text{per unit price}}_{2017}\right)}_{\text{Milk}}\\ +{\left({\text{Quantity produced}}_{2017}\times {\text{per unit price}}_{2017}\right)}_{\text{Honey}}\end{array}\right]\\ =\left(200\times 1\right)+\left(100\times 2\right)\\ =200+200\\ =400\end{array}$

Thus, the nominal GDP of 2017 is $400.

Similarly, the quantity produced in 2018 was 200 quarts of milk and 100 quarts of honey but the prices increased to $2 and $4, respectively. Thus, the nominal GDP of 2018 can be calculated as follows:

$\begin{array}{c}{\text{Nominal GDP}}_{2018}=\left[\begin{array}{l}{\left({\text{Quantity produced}}_{2018}\times {\text{per unit price}}_{2018}\right)}_{\text{Milk}}\\ +{\left({\text{Quantity produced}}_{2018}\times {\text{per unit price}}_{2018}\right)}_{\text{Honey}}\end{array}\right]\\ =\left(200\times 2\right)+\left(100\times 4\right)\\ =400+400\\ =800\end{array}$

Thus, the nominal GDP of 2018 is $800.

The real GDP can be calculated by multiplying the quantity produced with the base year price level. Since the base year is 2016, the nominal GDP of 2016 will be equal to the real GDP of 2016, which is equal to $200.

In the case of 2017, the real GDP can be calculated by multiplying the 2017 quantity with the 2016 price as follows:

$\begin{array}{c}{\text{Real GDP}}_{2017}=\left[\begin{array}{l}{\left({\text{Quantity produced}}_{2017}\times {\text{per unit price}}_{2016}\right)}_{\text{Milk}}+\\ {\left({\text{Quantity produced}}_{2017}\times {\text{per unit price}}_{2016}\right)}_{\text{Honey}}\end{array}\right]\\ =\left(200\times 1\right)+\left(100\times 2\right)\\ =200+200\\ =400\end{array}$

Thus, the real GDP of 2017 is $400.

In the case of 2018, the real GDP can be calculated by multiplying the 2018 quantity with the 2016 price. Since there is no change in the quantity produced in 2018 and 2017 in the two commodities of milk and honey, there will be no change in the real GDP of the two years and thus, the real GDP of 2018 will be the same as 2017, which is $400.

The GDP deflator is the implicit price deflator. It can be calculated by dividing the nominal GDP with the real GDP and multiplying the value with 100 as follows:

${\text{GDP Deflator}}_{2016}=\frac{{\text{Nominal GDP}}_{2016}}{{\text{Real GDP}}_{2016}}\times 100$

Thus, by substituting the values of nominal and real GDP in the equation, we can calculate the GDP deflator as follows:

$\begin{array}{c}{\text{GDP Deflator}}_{2016}=\frac{{\text{Nominal GDP}}_{2016}}{{\text{Real GDP}}_{2016}}\times 100\\ =\frac{200}{200}\times 100\\ =100\end{array}$

Thus, the GDP deflator in 2016 is 100. Similarly, the GDP deflator for 2017 can be calculated as follows:

$\begin{array}{c}{\text{GDP Deflator}}_{2017}=\frac{{\text{Nominal GDP}}_{2017}}{{\text{Real GDP}}_{2017}}\times 100\\ =\frac{400}{400}\times 100\\ =100\end{array}$

Thus, the GDP deflator in 2017 is also 100.

The GDP deflator for 2018 can be calculated as follows:

$\begin{array}{c}{\text{GDP Deflator}}_{2018}=\frac{{\text{Nominal GDP}}_{2018}}{{\text{Real GDP}}_{2018}}\times 100\\ =\frac{800}{400}\times 100\\ =200\end{array}$

Thus, the GDP deflator in 2018 is 200.

These values can be tabulated as follows:

Table 1

Year	Nominal GDP	Real GDP	GDP Deflator
2016	$200	$200	100
2017	$400	$400	100
2018	$800	$400	200

Economics Concept Introduction

Concept introduction:

Gross Domestic Product (GDP): It is the summation of the monetary value of all the goods and services produced within the political boundary of a country, within a financial year.

GDP deflator: It is an implicit price deflator.

Sub part (b):

To determine

The Percentage change in nominal and real GDP and GDP deflator.

Explanation of Solution

The percentage change in nominal GDP can be calculated by the following formula:

$\text{Percentage change in Nominal GDP}=\frac{\left({\text{Nominal GDP}}_{\text{n}}-{\text{Nominal GDP}}_{\text{n}-1}\right)}{{\text{Nominal GDP}}_{\text{n-1}}}\times 100$

Thus, by substituting the values for the current year and previous year, we can calculate the percentage change in the nominal GDP as follows:

$\begin{array}{c}{\text{Percentage change in Nominal GDP}}_{2017}=\frac{\left({\text{Nominal GDP}}_{2017}-{\text{Nominal GDP}}_{2016}\right)}{{\text{Nominal GDP}}_{2016}}\times 100\\ =\frac{\left(400-200\right)}{200}\times 100\\ =100\end{array}$

Thus, the percentage change in nominal GDP of 2017 is 100 percent.

$\begin{array}{c}{\text{Percentage change in Nominal GDP}}_{2018}=\frac{\left({\text{Nominal GDP}}_{2018}-{\text{Nominal GDP}}_{2017}\right)}{{\text{Nominal GDP}}_{2017}}\times 100\\ =\frac{\left(800-400\right)}{400}\times 100\\ =100\end{array}$

Thus, the percentage change in nominal GDP of 2018 is also 100 percent.

Similarly, the percentage change in real GDP and GDP deflator can be calculated as follows:

$\begin{array}{c}{\text{Percentage change in Real GDP}}_{2017}=\frac{\left({\text{Real GDP}}_{2017}-{\text{Real GDP}}_{2016}\right)}{{\text{Real GDP}}_{2016}}\times 100\\ =\frac{\left(400-200\right)}{200}\times 100\\ =100\end{array}$

The percentage change in real GDP of 2017 is 100 percent.

$\begin{array}{c}{\text{Percentage change in Real GDP}}_{2018}=\frac{\left({\text{Real GDP}}_{2018}-{\text{Real GDP}}_{2017}\right)}{{\text{Real GDP}}_{2017}}\times 100\\ =\frac{\left(400-400\right)}{400}\times 100\\ =0\end{array}$

The percentage change in real GDP of 2018 is 0 percent.

The percentage change in the GDP deflator can be calculated as follows:

$\begin{array}{c}{\text{Percentage change in GDP deflator}}_{2017}=\frac{\left({\text{GDP deflator}}_{2017}-{\text{GDP deflator}}_{2016}\right)}{{\text{GDP deflator}}_{2016}}\times 100\\ =\frac{\left(100-100\right)}{100}\times 100\\ =0\end{array}$

Thus, the percentage change in GDP deflator of 2017 is 0 percent.

$\begin{array}{c}{\text{Percentage change in GDP deflator}}_{2018}=\frac{\left({\text{GDP deflator}}_{2018}-{\text{GDP deflator}}_{2017}\right)}{{\text{GDP deflator}}_{2017}}\times 100\\ =\frac{\left(200-100\right)}{100}\times 100\\ =100\end{array}$

Thus, the percentage change in GDP deflator of 2018 is 100 percent.

The prices in the economy remain the same in the year 2016 and 2017, which leads to no change in the percentage change in the GDP deflator. This is why the GDP deflator percentage change is zero. Similarly, the output levels remain the same in the years 2017 and 2018, which leads to the value of percentage change in the real GDP to remain at zero.

Economics Concept Introduction

Concept introduction:

Gross Domestic Product (GDP): It is the summation of the monetary value of all the goods and services produced within the political boundary of a country, within a financial year.

GDP deflator: It is an implicit price deflator.

Sub part (c):

To determine

Economic well-being.

Explanation of Solution

The economic well-being increased much larger in the year of 2017, when compared to 2016 and 2018. This result is obtained from the analysis of the data that the real GDP remained the same in 2018 as the real GDP in the 2017. Thus, there were no changes in the real GDP after 2017. But after 2016, the real GDP increased from $200 to $400 in 2017. This means that the well-being rose more in 2017. Another reason why the well-being didn’t rise in 2018 was the price hike. The output remained the same, whereas prices doubled.

Economics Concept Introduction

Concept introduction:

Gross Domestic Product (GDP): It is the summation of the monetary value of all the goods and services produced within the political boundary of a country, within a financial year.