Question

Tropical Republic produces only bananas and coconuts. The base year is 2013 , and the table gives the quantities produced and the market prices. $$\begin{array}{lcc} \text { Quantities } & 2013 & 2014 \\ \hline \text { Bananas } & 800 \text { bunches } & 900 \text { bunches } \\ \text { Coconuts } & 400 \text { bunches } & 500 \text { bunches } \\ \text { Prices } & 2013 & 2014 \\ \hline \text { Bananas } & \$ 2 \text { a bunch } & \$ 4 \text { a bunch } \\ \text { Coconuts } & \$ 10 \text { a bunch } & \$ 5 \text { a bunch } \end{array}$$ Calculate real GDP in 2014 expressed in baseyear prices.

Short answer

Real GDP in 2014 is $6800

Step-by-step solution

- Understand Real GDP

Real GDP is the measure of a country's total economic output adjusted for price changes (inflation or deflation). This means using the base year's prices to value the production of goods and services in other years.

- Identify Base Year Prices

From the data provided, the base year is 2013. The prices for 2013 are: Bananas = \(2 per bunch, Coconuts = \)10 per bunch.

- Gather Quantity Data for 2014

The quantities produced in 2014 are: Bananas = 900 bunches, Coconuts = 500 bunches.

- Calculate Real GDP for 2014

Use the base year prices to value the quantities produced in 2014. For Bananas: \[ \text{Quantity}_{2014} \times \text{Price}_{2013} = 900 \text{ bunches} \times 2 \frac{\text{dollars}}{\text{bunch}} = 1800 \text{ dollars} \]. For Coconuts: \[ \text{Quantity}_{2014} \times \text{Price}_{2013} = 500 \text{ bunches} \times 10 \frac{\text{dollars}}{\text{bunch}} = 5000 \text{ dollars} \].

- Sum the Values to Get Real GDP

Add the value of bananas and coconuts to calculate the total Real GDP in 2014: \[ \text{Real GDP}_{2014} = 1800 \text{ dollars} + 5000 \text{ dollars} = 6800 \text{ dollars} \].

Key concepts

Base year prices

Base year prices are essential for calculating Real GDP. The base year is a benchmark year from which we measure economic activity over time. This is done to compare the economic output of different years accurately. By using the prices of goods and services from the base year, we eliminate the effects of inflation or deflation. This makes it easier to see the real growth in production. In our Tropical Republic example, 2013 is chosen as the base year. Therefore, the prices in 2013 (\(2 for bananas and \)10 for coconuts) are used to calculate Real GDP for later years.

Economic output

Economic output refers to the quantity of goods and services produced in an economy. To measure it accurately, we consider both the quantity produced and the price of these goods at base year prices. In 2014, Tropical Republic produced 900 bunches of bananas and 500 bunches of coconuts. Measuring economic output helps in understanding the overall production capacity and growth of the economy. By using base year prices, we can determine the Real GDP, giving a clear picture of true economic output without the distortions from price changes.

Price adjustment

Price adjustment is the process of converting the value of goods and services from their current prices to the base year's prices. This is crucial for eliminating the effects of inflation or deflation when comparing economic data across different years. For instance, in our example, the price of bananas rose from \(2 in 2013 to \)4 in 2014, and the price of coconuts dropped from \(10 to \)5. Using the base year prices, we adjust these values to reflect the true quantity produced without the influence of price changes. This helps in calculating the Real GDP more accurately.

Inflation

Inflation is the increase in the general price level of goods and services in an economy over a period of time. When prices inflate, the money's purchasing power decreases. This distorts the real value of economic output. In the Tropical Republic example, the price of bananas doubled from 2013 to 2014, reflecting inflation in the price of bananas. Calculating Real GDP using base year prices helps to remove this inflation effect, providing a clearer picture of actual production increases rather than price increases.

Deflation

Deflation is the decrease in the general price level of goods and services. This increases the purchasing power of money. However, like inflation, deflation can distort the real value of economic output when prices fall. In our example, the price of coconuts fell from \(10 in 2013 to \)5 in 2014, indicating deflation for coconuts. By using the consistent base year prices (2013 prices), we can calculate Real GDP in 2014 without the deflation effect. This ensures that the measured economic growth is due to actual increases in production rather than changes in prices.