Question

If GDP rose from \(\$ 6\) trillion to \(\$ 9\) trillion and prices rose by 50 percent over this period, \((\mathrm{LO})\) a) real GDP fell by 100 percent b) real GDP fell by 50 percent c) real GDP stayed the same d) real GDP rose by 50 percent e) real GDP rose by 100 percent

Short answer

Real GDP rose by 50 percent over the given period. The correct answer is: d) real GDP rose by 50 percent.

Step-by-step solution

Calculate the Initial Real GDP

First, we will calculate the initial real GDP (GDP_0_real) using the formula: \[GDP_0_real = \frac{GDP_0_nominal}{1 + \frac{Inflation_0}{100}}\] Where \(GDP_0_nominal = \$6\:trillion\), and \(Inflation_0 = 50\%\). \[GDP_0_real = \frac{6\:trillion}{1 + \frac{50}{100}} = \frac{6\:trillion}{1.5} = \$4\:trillion\]

Calculate the Final Real GDP

Now, we calculate the final real GDP (GDP_1_real) using the formula: \[GDP_1_real = \frac{GDP_1_nominal}{1 + \frac{Inflation_1}{100}}\] Where \(GDP_1_nominal = \$9\:trillion\), and \(Inflation_1 = 50\%\). \[GDP_1_real = \frac{9\:trillion}{1 + \frac{50}{100}} = \frac{9\:trillion}{1.5} = \$6\:trillion\]

Calculate the Percentage Change in Real GDP

Finally, we can calculate the percentage change in real GDP using the following formula: \[\% \:change\:in\:real\:GDP = \frac{(GDP_1_real - GDP_0_real)}{GDP_0_real} \times 100\%\] \[\% \:change\:in\:real\:GDP = \frac{(\$6\:trillion - \$4\:trillion)}{\$4\:trillion} \times 100\%\] \[\% \:change\:in\:real\:GDP = \frac{\$2\:trillion}{\$4\:trillion} \times 100\% = 50\%\] According to our calculation, Real GDP rose by 50 percent over the given period. So, the correct answer is: d) real GDP rose by 50 percent

Key concepts

Understanding Nominal GDP

Nominal GDP, often just referred to as GDP, measures the total value of all goods and services produced in a country at current market prices. This means it doesn't adjust for inflation, allowing you to see the face value of economic output.

• Face Value Measurement: Since nominal GDP includes current market prices, it can be affected by changes in price levels and inflation. This can sometimes give a misleading picture of economic growth.
• Annual Figures: Nominal GDP is often reported annually or quarterly, providing a snapshot of a country's economic activity.
• Economic Indicator: Economists and policymakers use nominal GDP as one of several indicators to assess an economy's overall performance.

When evaluating economic growth, it’s essential to interpret nominal GDP carefully. Price changes can skew perceptions of real economic growth, so complement it with other measures like real GDP to get a full picture.

Exploring Inflation

Inflation is a key concept in economics that refers to the rate at which the general level of prices for goods and services rises, eroding purchasing power. An inflation rate of 50%, as used in the exercise, indicates a significant increase in prices over time.

• Causes of Inflation: Inflation can result from demand-pull factors, where demand exceeds supply, or cost-push factors, where production costs rise.
• Effects on Purchasing Power: As inflation increases, each unit of currency buys fewer goods and services, reducing real purchasing power for consumers.
• Measuring Inflation: Economists use indices like the Consumer Price Index (CPI) or the Producer Price Index (PPI) to measure inflation.

Understanding inflation is vital for making informed economic decisions, whether you’re setting policies as a government or making personal investment choices.

Calculating Percentage Change in GDP

The concept of percentage change in GDP is important in assessing the growth or decline of an economy over time. By calculating how much real GDP has increased or decreased, we get a better understanding of true economic progress or regression.

• Formula: The percentage change is calculated using \[\%\:change = \frac{(GDP_{final} - GDP_{initial})}{GDP_{initial}} \times 100\% \]
• Significance of Real Terms: Calculating the percentage change using real GDP, which adjusts for inflation, gives a more accurate reflection of actual growth compared to nominal figures.
• Example Application: In the exercise, a change from \(4 trillion to \)6 trillion in real GDP indicates a 50% increase, highlighting an actual rise in economic productivity after accounting for inflation.

By understanding how to calculate and interpret these changes, we can better gauge the health and direction of an economy.