Measuring GDP

Gross domestic product, or GDP, is the most frequently used measure of an economy's output and is linked to a country's standard of living. Nominal GDP is simply the market value of the final goods and services produced in a country during a given period, usually a year. However, economists focus on real GDP, which adjusts nominal GDP for inflation. Real GDP measures a country's production of final goods and services in a particular year's prices and allows economists to compare economic activity across time and across locations. Economic growth is measured as the percentage change in a country's real GDP from one year to the next.

Exploration: What's the relationship between nominal and real GDP?

The applet above illustrates the prices and quantities of two goods produced in an economy during two different time periods. The prices and quantities of each of the items can be changed to determine the effects of these changes on nominal and real GDP, as well as their growth rates. Use the mouse to click on any of the boldfaced price or quantity cells and change the number in the highlighted gray area to a new value; click the Reset button restore the original values.

1. Double the prices and quantities produced for each of the goods in year 2. What happens to nominal and real GDP in year 2 and the growth rates of nominal and real GDP between the two years? Why is the growth rate of nominal GDP greater than the growth rate of real GDP between the two years?
   
   
2. Click the Reset button to restore the original values. Now double the quantities produced for each of the goods in year 2. What happens to nominal and real GDP in year 2 and the growth rates of nominal and real GDP between the two years?
   
   
3. Click the Reset button to restore the original values. Double the prices for each of the goods in year 2. What happens to nominal and real GDP in year 2 and the growth rates of nominal and real GDP between the two years?
   
   
4. Based on your analysis in problem #3, which is the better measure of economic activity, real GDP or nominal GDP? Why?

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