ECON203
Principles of Macroeconomics
Week 4
Topic: Related Measures & GDP uses
and limitations
Dr. Mazharul Islam
1
Lesson Objectives
To learn about
After studying these topics you should be able to:
• Distinguish between nominal and real GDP
• Calculation Real GDP
• The Uses and Limitations of Real GDP
• GNP
Dr. Mazharul Islam
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NOMINAL vs REAL GDP
• Nominal GDP is GDP measured in current Saudi
Riyal, or the current prices we pay for final goods
and services. When a variable is measured in
current prices, it is described in nominal terms.
• Real GDP is the value of a nation's total final goods
and services, adjusted for price changes. It valued
at the prices of a reference base year. A base year
is the year we choose against which to compare all
other years. Real GDP is also called gross domestic
product in constant prices (Riyals). Note that real
GDP is also known as constant-price GDP
and inflation-corrected GDP.
Dr. Mazharul Islam
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Calculating Real GDP
To get real GDP we multiply the quantity of the final
good or the service produced in the year by its price in
the reference base year. Example:
A Three-Good Economy
(1)
(2)
PRODUCTION
2010
2012
Q1
Q2
(3)
(4)
PRICE PER UNIT
2010
2012
P1
P2
(5)
(6)
(7)
(8)
GDP IN
2010
IN
2010
PRICES
P 1 x Q1
GDP IN
2012
IN
2010
PRICES
P 1 x Q2
GDP IN
2010
IN
2012
PRICES
P 2 x Q1
GDP IN
2012
IN
2012
PRICES
P 2 X Q2
Good A
6
11
$.50
$ .40
$3.00
$5.50
$2.40
$4.40
Good B
7
4
.30
1.00
2.10
1.20
7.00
4.00
Good C
10
12
.70
.90
7.00
8.40
9.00
10.80
$12.10
$15.10
$18.40
$19.20
Nominal
GDP
in 2010
Real
GDP in
2012
Total
Real
GDP in
2010
Dr. Mazharul Islam
Nominal
GDP
in 2012
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Mathematical Note: Chained-Dollar Real GDP
–Starting with real GDP in
2005 of $125 million and the
growth rates in Table 3, real
GDP in each year since 2005 is
calculated as follows:
–Real GDP in 2006 is 8
percent higher than the $125
million in 2005, which is $135
million.
–The figure illustrates the
linking back to the base year.
Dr. Mazharul Islam
Calculating Real GDP
Test:
Let say Saudi Arabia produced only one good which
is Dates. The nominal GDP in 2010 was SAR 100
million with SAR0.50 per kg. The nominal GDP in
2012 was SAR 120 million with SAR0.55 per kg.
a.
b.
c.
d.
e.
How many % nominal GDP increased in 2012?
Calculate the quantity dates produced in 2012.
Calculate the real GDP in 2012.
Calculate actual/real growth.
Why not use two consecutive year’s nominal GDP to calculate
economic growth?
Dr. Mazharul Islam
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The General Formula for
Calculating a Growth Rate
New _ Value  Old _ Value
Percent _ Change  % 
100
Old _ Value
No min alGDP 2012
Q 2012 
Pr ice 2012


Re alGDP 2012  Q 2012  P 2010
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Importance of Real GDP
Real GDP is important mainly for the following
reasons:
1. To know that how much the economy is actually producing. It
means to compute economic growth, known as the GDP
growth rate. The computed growth rate is using to compare
the standard of living over time.
2. To compare the size of economies throughout the world. That
means to compare the standard of living among countries.
3. The GDP growth rate is critical for investors countries with
strong growth attract more investors for their corporate
stocks, bonds and even their own independent debt.
4. To track the course of the business cycle that means you can
tell where the economy is in the business cycle.
Dr. Mazharul Islam
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The Business Cycle
The business cycle is the periodic but irregular
up-and-down movement in production.
–Every cycle has two phases:
1. Expansion
2. Recession
–and two turning points:
1. Peak
2. Trough
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The Business Cycle
Definitions of Four phases of Business Cycle :
– An expansion is a period during which real GDP
increases—A speedup in the pace of economic activity
– movement from a trough to a peak.
– A severe contraction, in which real GDP decreases for
at least two quarters, is called a recession - A slowdown
in the pace of economic activity - movement from a
peak to trough.
–Through point is the lower turning point of a business
cycle, where a recession turns into an expansion.
–Peak is the upper turning of a business cycle,
where an expansion turns into a recession.
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Real GDP
Time
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The GDP Deflator
GDP price deflator measures the general price
level i.e. the average price level of all final
goods and services. It is an index of the prices
of all goods and services included in GDP. It is
calculated from the ratio of nominal GDP to
real GDP. the GDP deflator is a measure of
price inflation/deflation with respect to a
specific base year.
NGDPt
GDP _ Deflatort 
100
RGDPt
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The Inflation Rate
Inflation Rate is The percentage increase in
the price level from one year to the next. We
can use the growth rate formula to calculate
the Inflation Rate.
Inflation Rate Between two years =
[(GDP Deflatort – GDP Deflatort-1)/GDP Deflatort-1] x 100
Dr. Mazharul Islam
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The Inflation Rate
Inflation Rate is also calculate by using
Consumer Price Index (CPI). The percentage
change in CPI from one year to the next.
Calculation formula as follows.
Inflation Rate Between two years =
[(CPIt – CPIt-1)/CPIt-1] x 100
Dr. Mazharul Islam
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Consumer Price Index
(CPI)
A CPI is a measure of the average change over
time in the prices paid by households
consumers who are resident in the municipal
city for a fixed basket of goods and services. It is
an index of the prices of a fixed basket of final
goods and services included in GDP.
Dr. Mazharul Islam
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Inflation Rate by Using
CPI
The CPI in Saudi Arabia was 172.1 (June 2010) and
178.3 (June 2012).
Calculate Saudi’s annual inflation rate.
– What does the result mean?
– What are the difference between GDP deflator
and CPI?
Dr. Mazharul Islam
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Gross National Product
(GNP)
Gross National Product is the market value
of all final goods and services produced
anywhere in the world by the factors of
productions supplied by the residents of that
country in a given period of time.
• Examples : Nikes’ income from the capital
that it supplies to its Saudi Arabia shoe factory
is part of US GNP but not part of US GDP.
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• GNP= GDP+ net factor income received
from abroad
• Net factor income received from abroad =
factor income received from abroad factor income paid to other countries
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Limitations of GDP as a measure
of Standard of Living
GDP excludes :
1. Household production of goods and
services , because these are not
bought or sold in the market.
Examples:
So GDP underestimates the value of
production.
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Limitations of GDP as a measure
of Standard of Living
2. Underground Production: it is the
production of goods and services
hidden from the view of government
because people want to avoid taxes
and regulations or their actions are
illegal. Underground Production is
unreported so it is omitted from GDP
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Limitations of GDP as a measure
of Standard of Living
3. Leisure Time: It is an economic good .
You must choose between work or
leisure time.
When leisure time increases that
means our standard of living increases.
The improvements of our standard of
living are not measured in real GDP.
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Limitations of GDP as a measure
of Standard of Living
4. Environment quality:
Pollution is an economic evil. The more
we pollute our environment, the lower
is our standard of living(other things
being the same).
This lowering of our standard of living
is not measured in GDP.
Dr. Mazharul Islam
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Other influences on the Standard
of Living
1. Health and life expectancy: Good health and
long life do not show up directly in GDP.
On the other side we do not take into
account the negative effect of bad diseases.
2. Political freedom and social justice: A
country might have a very large GDP per
person but have limited political freedom
and social justice. Such a country would be
regarded as having lower standard of living
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Limitations and inaccuracies of
GDP measures
Some questions on limitations and inaccuracies of GDP
measures
Household production
 Examples? Why is this activity not included in
GDP?
 Environmental quality
 Examples? How can this problem be addressed?
 Underground economic activity
 Examples? Do you think this is a larger/smaller
issue in Greece or Vietnam?
Political freedom and social justice
 Examples of high growth economies with limited
freedom?
Dr. Mazharul Islam
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Now it’s over for
today. Do you have
any question?
Dr. Mazharul Islam
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