Holt 7525-9 S15_IT

Example 16B: GDP was $6,174 billion in 1991 and was $6,539 billion in 1992. What was Real
GDP in 1992, adjusted to the 1991 price level? The GDP deflator was 69.0 in 1991 and was 70.6
in 1992.
Real GDP (1992) = $6,539B ÷ (70.6 ÷ 69.0) = $6,539B ÷ 1.0232 = $6,391B
In this case, the increase in nominal GDP was caused by both an increase in Real GDP and an
increase in the price level.
Example 16C: GDP was $14,478 billion in 2007 and was 14,719 billion in 2008. What was Real
GDP in 2008, adjusted to the 2007 price level? The GDP deflator was 97.3 in 2007 and was 99.3
in 2008.
Real GDP (2008) = $14,719B ÷ (99.3 ÷ 97.3) = $14,719B ÷ 1.0206 = $14,422B
In this case, even though nominal GDP increased from 2007 to 2008, Real GDP did not. Real
GDP decreased from 2007 to 2008. The increase in nominal GDP was due solely to the increase
in the price level (inflation).
As illustrated in the examples above, an increase in nominal GDP from year to year does not
necessarily mean that production has increased. To determine if production has increased, we
compute Real GDP. Absolute economic growth refers to an increase in Real GDP. (In Chapter
14, we distinguish between absolute economic growth and per capita economic growth.)
The Business Cycle
Real GDP tends to behave in a cyclical manner, called the business cycle. The upturns and
downturns in the business cycle are unpredictable in terms of when they will occur, how long they
will last, and how severe they will be. The four phases of the business cycle are called:
1. Expansion – when Real GDP is increasing.
2. Peak – the highest phase of the business cycle.
3. Contraction – when Real GDP is decreasing.
4. Trough – the lowest phase of the business cycle.
Appendix: Flaws in GDP as a Measure of Standard of Living
Gross domestic product (GDP) measures the market value of all final goods and services
produced annually. As such, GDP, particularly when stated on a per capita basis, is considered a
measure of a nation’s standard of living. As a measure of standard of living, GDP contains a
number of flaws, including:
1. GDP does not include nonmarket production. Nonmarket production (e.g. do-it-yourself)
can be very valuable and has a strong impact on a nation’s standard of living. But nonmarket
production is not included in GDP. GDP comparisons between a nation that has a relatively
large amount of nonmarket production and a nation that has a relatively small amount of
nonmarket production will be misleading. Nonmarket production is typically a larger share of
total output in less developed countries than in developed countries. Comparisons of GDP
between developed countries and less developed countries will thus tend to overstate the
difference in standard of living.
2. GDP does not include underground (unreported) production. Production that is
unreported for tax evasion purposes is nonetheless valuable production that increases a
nation’s standard of living. And production that is unreported because it is illegal also has a
market value and arguably increases a nation’s standard of living. Underground production is
typically a larger share of total output in less developed countries than in developed countries.
Comparisons of GDP between developed countries and less developed countries will thus
tend to overstate the difference in standard of living.
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
Measuring Total Output: GDP 5 - 6