Our example pretended that there was only a single good produced in the economy—pizza. In real economies, millions of different goods and services are produced, ranging from cars at an assembly plant to haircuts sold by a local barber. If our goal is to measure the overall output of an economy, we are faced with the problem of how to add together these goods and services. How do you add 60,000 cubic meters of natural gas, 1,000 trucks, and 2,000 head of cattle (to pick just a few examples of goods produced in Argentina)? We need a common denominator. Economists use the market value of the goods and services. This means that the common denominator is dollars in the United States, pesos in Argentina, kroner in Sweden, euros in Portugal, and so on. Nominal GDP equals total output produced in a year, valued at the actual market prices prevailing in that year. We choose market value for two reasons. One is simplicity: data on the market prices of goods and services are relatively easy to come by. The second reason is much more important. Market value tells us how much people are willing to pay for different goods and services, which gives us a measure of the relative value of different commodities. For example, if a new laptop computer costs $2,000 and a new hardcover novel costs $20, then the market is telling us that people are willing to trade off these goods at the rate of 100 novels to 1 laptop. In effect, the market is telling us that the laptop is 100 times more valuable than the novel. 1
Let’s look at an example of the calculation.Table 3.1 Calculating Nominal GDP considers a very small economy that produces three goods and services: T-shirts, music downloads, and meals. We show data for two years. To calculate GDP in 2012, we take the market value of the T-shirts ($20 × 10 = $200), the market value of the music downloads ($1 × 50 = $50), and the market value of the meals ($25 × 6 = $150). Adding these, we discover that nominal GDP is $400:
($20 × 10) + ($1 × 50) + ($25 × 6) = $200 + $50 + $150 = $400.
Doing the same operations for 2013, we find that nominal GDP is $442:
($22 × 12) + ($0.80 × 60) + ($26 × 5) = $264 + $48 + $130 = $442.
We can see that lots of things changed between the two years. The price of T-shirts and meals slightly increased, while music downloads became cheaper. Firms produced more T-shirts and music downloads but fewer meals.
|
Year |
T-shirts |
Music Downloads |
Meals |
Nominal GDP($) |
||||||
|
Price($) |
Quantity |
Price($) |
Quantity |
Price($) |
Quantity |
|||||
|
2012 |
20.00 |
10 |
1.00 |
50 |
25.00 |
6 |
400.00 |
|||
|
2013 |
22.00 |
12 |
0.80 |
60 |
26.00 |
5 |
442.00 |
|||
On the surface, 2013 appears to have been a good year in this economy. Nominal GDP increased substantially relative to 2012. Dig a little deeper, however, and it is harder to interpret this change. Production increased for some products and decreased for others. Some prices increased, and others decreased. Was 2013 really better than 2012? We come back to this question shortly.
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