Application Exercise 6b: ‘real’ versus ‘nominal’ values
- The production figure of $100 is arrived at by multiplying the price of the pens (i.e. $1) by the volume of pens sold (i.e. 100).
- The production figure of $200 in year 2 was arrived at by multiplying the same volume of 100 by the new price of $2.
- The economy is no better off because the higher value of pen production ($200) has only occurred because of a rising price rather than a rise in the volume of pens produced and sold.
- This necessarily means that any focus on the dollar value of economic activity ($200) is misleading because it implies that the value of production and income has risen to make us better. However, we are no better off than before because the real value of production and income has not changed.
- Nominal GDP would be calculated by multiplying the new price of $1.50 by the new volume of 200. This equates to a figure of $300. However, part of this increase in value has occurred because of a price rise and part is occurred because of an increase in the actual volume of goods produced. To arrive at the real value of production we need to remove the price effect. This is done by multiplying the new quantity of 200 by the old price of $1 to arrive at a real value of production in the 2 of $200. Accordingly, the real value of production in this scenario has increased from $100 to $200 which means that we are better off.