UNIT 2: Nominal GDP, Real GDP, Inflation and Interest Rates.

NOMINAL GDP

It is the value of output produced in the current year prices. Nominal GDP from year to year increases if either output or prices increase (it is used for measuring inflation) 

formula= Price multiplied by Quantity.

REAL GDP

It is the value of output produced in constant or base year prices (it is adjusted for inflation). Real GDP can increase from year to year only if Quantity increases (used for economic growth)

	Quantity in 2015	Quantity in 2016	Price in 2015	Price in 2016
Pizzas	5	6	$10	$15
CDs	4	5	$15	$20
Stereos	2	4	$550	$600
Automobile	1	1	$10,000	$12,000

Real GDP formula =PRICE multiplied by QUANTITY

Real GDP in 2015 = $11,210

Real GDP in 2016 = $12,335

Nominal GDP in 2015 = $11,210

Nominal GDP in 2016 = $14,590

GDP DEFLATOR

This is a Price Index used to adjust from Nominal to Real GDP.

Formula = Nominal GDP / Real GDP * 100

In the base year = GDP Deflator = 100.

For years after the base year GDP deflator is greater than 100. For years before the base year, GDP deflator is less than 100.

CONSUMER PRICE INDEX (CDI)

It is the most commonly used measurement of inflation. It measures the market basket of goods for a typical urban American family.

formula= price of a market basket of goods in the current year/price of a market basket of goods in the base year * 100

INFLATION

price index in year 2- price index in year 1 / price index in year 1 * 100

Real vs Nominal interest Rates.

Real interest rate
it is the percentage increase in purchasing power the burrower must pay the lender for a loan. real interest rate is adjusted for inflation. purchasing power is decreased when one pays more than they purchased.

formula for real interest rate : Norminal Interest -Inflation rate.

Nominal interest rate
it is the percentage increase in money the burrower must pay the lender for a loan.
it is not adjusted for inflation.
formula: expected interest rate + inflation premium.

COLA Adjustment

COLA is an automatic wage increase when inflation occurs. it is used by New York and California