01.01. - Real vs Nominal Variables and Indexes

Question 1

What is the difference in real and nominal GDP?

Answer 1

• nominal: includes both price and quantity changes (“The total value of production using current market prices to determine the value of each unit that is produced”)
• real: only includes changes in price (“The total value of production using market prices from a specific base year to determine the value of each unit that is produced”)

Question 2

What is the GDP deflator?

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Answer 2

• the ratio of nominal GDP to real GDP
• measure of how prices of goods and services produced in a country have risen since the base year
• (Nominal GDP / Real GDP) * 100
• change between two years: (new-old)/old

Question 3

What is the Consumer Price Index? (CPI)

Answer 3

• the cost of buying a basket of goods and services in the current year divided by the cost of the same basket in the base year

Question 4

What is the difference between the GDP delfator and the CPI?

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Answer 4

• GDP basket includes items that households do not consume (e.g. nuclear power plants)
• CPI basket includes items that households consume, but are not part of GDP (e.g. laptops produced in china)
• baskets put different weights on different goods (e.g. housing expenditures weigh more in CPI)

Question 5

What is the inflation rate and how can it be calculated?

Answer 5

• inflation rate is the year-over-year percentage change in a price index
• (price index new - price index old) / price index old
• can be calculated based on both the GDP deflator or the CPI