Question

Suppose that this year’s nominal GDP is \(16 trillion. To account for the effects of inflation, we construct a price-level index in which an index value of 100 represents the price level 5 years ago. Using that index, we find that this year’s real GDP is \)15 trillion. Given those numbers, we can conclude that the current value of the index is:

a. higher than 100.

b. lower than 100.

c. still 100.

Short answer

Option (a):higher than 100

Step-by-step solution

Meaning of nominal and real GDP

The nominal GDP shows the unadjusted value of the output produced within the country, and the real GDP shows the inflation-adjusted value of output produced within the country.

The price index is used to convert nominal GDP to real GDP and is given by:

$PriceIndex=\frac{NominalGDP}{RealGDP}\times 100$

Explanation for choosing option (a)

If the nominal GDP in the current year is $16 trillion and the real GDP is $15 trillion, then Price Index will be 106.66, as calculated below.

$$\begin{gathered} PriceIndex=\frac{NominalGDP}{RealGDP}\times 100 \\ =\frac{16trillion}{15trillion}\times 100 \\ =106.66 \end{gathered}$$

The price index is 106.66, which is higher than 100. Thus, option ‘a’ is correct.