It’s fairly straightfoward to calculate the nominal GDP (the current dollar value of output) for any year: multiply the quantity of each good produced by its selling price per unit in any given year and then add them all up. You can see this in the table. For Year 0, the economy produces 100,000 potatoes for a price of $1.00 per pound and 10 cars for a price of $10,000 per car. As you can see this results in a nominal GDP of $200,000.

  1. What is nominal GDP in Year 1 ?
  2. Increase the quantity of potatoes and cars produced in Year 0 by typing in larger quantities for those goods. What happens to nominal GDP ?
  3. Increase the price of potatoes and the price of cars produced in Year 0 by typing in larger prices for both goods. What happens to nominal GDP ?

    4. Nominal GDP can increase because real GDP increases or nominal GDP can increase because prices increase – that means it is impossible to compare nominal GDP in one year with nominal GDP in another year and determine what has happened to real GDP between those two years. For this reason, we must calculate real GDP holding prices constant. But, at what level? Traditionally, the U.S. Bureau of Economic Analysis – the government office that produces the GDP numbers – chose to hold prices constant at a particular year’s (the base year) price level. Suppose you choose Year 0 as the base year. This means you will calculate real GDP for Year 0 and Year 1 using the prices from Year 0 to value the output for each year.

  4. Type “0” in the box choosing the base year. What is real GDP in Year 0 and in Year 1 ?
  5. There is no particular reason for choosing Year 0 as the base year. Type “1” in the box choosing the base year. What is real GDP in Year 0 and in Year 1 ?

    6. The choice of base year makes a big difference in the calculated growth rate of real GDP. This created quite a problem when the base year was changed (which happened about every 5 years or so), because the historical growth rates were altered with every new base year. So the U.S. Bureau of Economic Analysis decided to go to a “chain weighted” calculation of real GDP. To calculate the growth rate of GDP between two years, the prices are held constant at the average of the two years. For the example in the table, the average prices are $1.10 for potatoes and $10,000 for cars.

  6. What is the growth rate of real GDP from Year 0 to Year 1 using the average prices ?
  7. What prices would you use to calculate the chain weighted growth rate of real GDP from Year 1 to Year 2 ?