Suppose an economy produces two products: Product A and Product B. This is the data for two years. By how much has the economy grown between Year 1 and Year 2?
Product
Year 1 Price Per Unit ($)
Year 1 Output (units)
Year 2 Price Per Unit ($)
Year 2 Output (units)
Product A
1.00
20
2.50
10
Product B
2.00
15
3.00
25
Answer: 20 per cent
Dataset - National Accounts
| Sectoral Balance | Year 1 Price Per Unit ($) | Year 1 Output (units) | Year 2 Price Per Unit ($) | Year 2 Output (units) |
| Product A | 1.00 | 20 | 2.50 | 10 |
| Product B | 2.00 | 15 | 3.00 | 25 |
The answer is c - 20 per cent
The System of National Income and Product Accounts (NIPA) is the framework assembled by national statisticians for measuring economic activity. The most important measure of production is Gross Domestic Product or GDP, which is the measure of all final goods and services evaluated at market prices which are produced per period of time, say a quarter or a year.
We call this the nominal GDP measure because it relates to current prices.
In the example provided, nominal GDP would be:
Year 1: (20 x $1.00) + (15 x $2.00) = $50
Year 2: (10 x $2.50) + (25 x $3.00) = $100
Change in nominal GDP = 100 per cent.
But when we talk about economic growth, we are referring to another concept - real GDP.
We need to understand that growth in GDP over time can be influenced by changes in market prices as well as output changes.
If we find that nominal GDP today is 100 times greater than it was a hundred years ago, does that mean that we enjoy 100 times more physical output?
Clearly not if prices have also risen.
Economists have devised ways of separating out the price change component of GDP increase from the actual output change.
The techniques used by the statistician in this regard go beyond our focus here.
The important point to understand is that 'real' GDP corrects the nominal GDP measure for changes in prices.
Thus, when we speak of economic growth, we are using the real GDP measure which has purged any price change impacts over time.
In the video accompanying the course in this section, I had some apples and oranges and we conducted the above experiment.
To isolate the output effects from the price effects, we would ask if prices were unchanged, what would the GDP measure be in Year 2.
If we do that calculation we are effectively computing a 'constant price' or 'fixed price' measure of GDP - which we call real GDP.
So to answer the question we need to do that calculation:
Year 1: (20 x $1.00) + (15 x $2.00) = $50 (so real and nominal GDP are identical at this point)
Year 2: (10 x $1.00) + (25 x $2.00) = $60 (this is real GDP in Year 2)
Change in real GDP = $10 or 20 per cent.