Question

An increase in _______ GDP guarantees that more goods and services are being produced by an economy.

1. nominal

2. real

Short answer

Option (b): real

Step-by-step solution

Explanation for the correct option “b”

The real GDP calculates the national income of an economy in real terms. It helps in comparing the GDP in different years according to the base year. The comparison explains whether the increase has occurred by a rise in prices or the quantity produced.

The real GDP is calculated based on constant prices to remove the price effect from the total production value.

For example, suppose there is a one-good economy. The price of a good increased from $2 to $6 in year 2, and the output decreased from $250 units to $100 units in year 2. The real GDP is calculated at the base year prices (=$2). Thus, the real GDP in year 1 would be $500 (=2×250) and $200 (=2×100) in year 2.

There is a fall in GDP from $500 in year 1 to $200 in year 2. The fall in the value is due to the fall in output production.

Explanation for the incorrect option “a”

The nominal GDP is just a monetary estimate of the total production in an economy during the year. It does not tell anything about the quantity of production.

It is calculated based on prevailing market prices. Therefore, it will include the price effect in the calculation of the economy’s worth.

For example, suppose there is a one-good economy. The price of a good increased from $2 to $6 in year 2, and the output decreased from $250 units to $100 units in year 2. The total GDP increased from $500 (=2×250) to $600 (=6×100) despite a fall in output production(150 units=250-100). This is the nominal GDP. The increase in the value comes from the prices and not from the output.