Question

g Suppose the economy has only the following three goods: Year Good Price Quantity 2014 Ice cream cones $2.50 1,000 Hot dogs $1.25 500 Surfboards $100.00 10 2015 Ice cream cones $3.50 800 Hot dogs $2.25 400 Surfboards $100.00 14 Calculate nominal GDP for 2014 and 2015. Calculate the percentage change in GDP from 2014 to 2015, first using 2014 prices and then using 2015 prices. Calculate the percentage change in real GDP from 2014 to 2015, using your answers from part (b). What is the GDP deflator for 2015 if it equals 1.0 in 2014?

Answer 1

Answer:

a. Nominal GDP for 2014 is $ 4125 and Nominal GDP for 2015 is $ 5100

b.

Percentage change in GDP from 2014 to 2015 (using 2014 prices) = -5,45%

Percentage change in GDP from 2014 to 2015 (using 2015 prices) = -9,3%

c.

Percentage change in real GDP from 2014 to 2015 (using 2014 prices) = -5,45%

Percentage change in real GDP from 2014 to 2015 (using 2015 prices) = -9,3%

They are the same answers from the previous point.

d. GDP deflator for 2015 = 130.769

Explanation:

a. Calculate nominal GDP for 2014 and 2015:

GDP for 2014:

To calculate nominal GDP we take the quantities of each product and multiply them by the corresponding prices for that year. That is:

                          P                Q             P*Q

Ice cream       2,50           1000          2500

Hot dogs        1,25             500           625    

Surfboards     100               10             1000

Then, we add the "P*Q" of each product. Therefore:

Nominal GDP for 2014: 2500 + 625 + 1000 = 4125

GDP for 2015:

To calculate nominal GDP we take the quantities of each product and multiply them by the corresponding prices for that year. That is:

                          P                Q             P*Q

Ice cream       3,50            800          2800

Hot dogs        2,25            400           900    

Surfboards     100               14             1400

Then, we add the "P*Q" of each product. Therefore:

Nominal GDP for 2015: 2800 + 900 + 1400 = 5100

b. Percentage change in GDP from 2014 to 2015.

Using 2014 prices:

First, we have to calculate GDP for each year using 2014 prices.

For 2014 is 4125, it is the same nominal GDP.

For 2015 is:

                         P                Q             P*Q

Ice cream       2,50            800          2000

Hot dogs        1,25             400           500

Surfboards     100               14             1400

Then, we add the "P*Q" of each product. Therefore:

Real GDP for 2015: 2000 + 500 + 1400 = 3900

Once these data are obtained, we calculate the variation in GDP from 2014 to 2015, with the following formula:

$GDP variation: \frac{(GDP_{2015}) (GDP_{2014})  }{GDP_{2014} }$. This multiplied by 100.

We replace:

$GDP variation = \frac{(3900)-(4125)}{(4125)} * 100 = -5,45%$

GDP variation from 2014 to 2015 = -5,45%

Using 2015 prices:

First, we have to calculate GDP for each year using 2015 prices.

For 2014 is:

                         P                Q             P*Q

Ice cream       3,50            1000        3500

Hot dogs        2,25             500         1125

Surfboards     100                10           1000

Then, we add the "P*Q" of each product. Therefore:

Real GDP for 2014: 3500 + 1125 + 1000 = 5625

For 2015 is 5100, it is the same nominal GDP.

Once these data are obtained, we calculate the variation in GDP from 2014 to 2015, with the following formula:

$GDP variation: \frac{(GDP_{2015}) (GDP_{2014})  }{GDP_{2014} }$. This multiplied by 100.

We replace:

$GDP variation = \frac{(5100)-(5625)}{(5625)} * 100 = -9,3%$

GDP variation from 2014 to 2015 = -9,3%

c. Calculate the percentage change in real GDP from 2014 to 2015.

Real GDP is equivalent to the quantities produced in a year multiplied by the prices of a reference year.

If we take 2014 as the reference year, we obtain the following results:

Real GDP for 2014 equals Nominal GDP for that year, that is: 4125

Real GDP for 2015 is 3900. We have obtained this result in the previous point.

Therefore, the variation rate is ((3900-4125)/4125)*100 = -5,45%

If we take 2015 as the reference year, we obtain the following results:

Real GDP for 2014 is 5625. We have obtained this result in the previous point as well.

Real GDP for 2015 equals Nominal GDP for that year, that is: 5100.

Therefore, the variation rate is ((5100-5626)/5100)*100 = -9,3%

d. GDP deflator for 2015.

To find the GDP deflator for 2015, the nominal GDP must be divided over the real one.

But how do we know what real GDP is? The exercise gives us a clue: it tells us that in 2014 the deflator is 1.0. This result is because both real and nominal GDP are equal. Then, real GDP that we should use is the one that uses 2014 prices. In fact, if we do this exercise we find the following:

GDP 2014 deflator: nominal GDP / real GDP

GDP deflator 2014: 4125 / 4125  = 1

Therefore, to find the 2015 deflator, we will use the nominal GDP of 2015 over real GDP (with 2014 prices). In doing so, we have this result:

GDP Deflator 2015: 5100 / 3900

GDP Deflator 2015: 130.769

Let us remind that nominal GDP of 2015 is 5100 (we found it in the first point of this exercise) and real GDP is 3900 (e found it in the second point of this exercise