Worth: Mankiw Economics 5e CHAPTER 2 The Data of Macroeconomics |23 the total number of dollars spent on bread in that year, Px Q. Real GDP is the number Caves o f bread produced in that year times the price of bread in some base year, Pbase x Q. The gDp deflator is the price of bread in that year elative to the price of bread in the base year, P/pbase. The definition of the GDp deflator allows us to separate nominal GDP into two parts: one part measures quantities(real GDP)and the other measures prices (the GDP deflator). That is Nominal GDP= Real GDP X GDP Deflator Nominal GDP measures the current dollar value of the output of the economy. Real GDP measures output valued at constant prices. The gDP deflator measures the price of output relative to its price in the base year. We can also write this equation as Real GDP Nominal GDP GDP Deflator In this form, you can see how the deflator earns its name: it is used to deflate (that is, take inflation out of nominal GDP to yield real GDP Chain-Weighted Measures of Real GDP We have been discussing real gdP as if the prices used to compute this measure never change from their base-year values. If this were truly the case, over time the prices would become more and more dated. For instance, the price of com- puters has fallen substantially in recent years, while the price of a year at college has risen. When valuing the production of computers and education, it would be misleading to use the prices that prevailed ten or twenty years ago. To solve this problem, the Bureau of Economic Analysis used to update period- ically the prices used to compute real GDP. About every five years, a new base year was chosen. The prices were then held fixed and used to measure year-to-year changes in the production of goods and services until the base year was updated In 1995, the bureau announced a new policy for dealing with changes in the base year. In particular, it now emphasizes chain-wveighted measures of real GDP With these new measures, the base year changes continuously over time. In essence, average prices in 2001 and 2002 are used to measure real growth from 2001 to 2002; average prices in 2002 and 2003 are used to measure real growth from 2002 to 2003; and so on. These various year-to-year growth rates are then put together to form a"chain that can be used to compare the output of goods and services between any two dates This new chain-weighted measure of real GDP is better than the more tradi- tional measure because it ensures that the prices used to compute real GDP are never far out of date. For most purposes, however, the differences are not impor tant. It turns out that the two measures of real GDP are highly correlated with each other. The reason for this close association is that most relative prices hange slowly over time. Thus, both measures of real GDP reflect the same thing: economy-wide changes in the production of goods and services. User JOENA: Job EFF01418: 6264_ch02: Pg 23: 24941#/eps at 1004 I Tue,Feb12,20028:404MUser JOEWA:Job EFF01418:6264_ch02:Pg 23:24941#/eps at 100% *24941* Tue, Feb 12, 2002 8:40 AM the total number of dollars spent on bread in that year, P × Q. Real GDP is the number of loaves of bread produced in that year times the price of bread in some base year, Pbase × Q. The GDP deflator is the price of bread in that year relative to the price of bread in the base year, P/Pbase. The definition of the GDP deflator allows us to separate nominal GDP into two parts: one part measures quantities (real GDP) and the other measures prices (the GDP deflator). That is, Nominal GDP = Real GDP × GDP Deflator. Nominal GDP measures the current dollar value of the output of the economy. Real GDP measures output valued at constant prices.The GDP deflator measures the price of output relative to its price in the base year.We can also write this equation as Real GDP = . In this form, you can see how the deflator earns its name: it is used to deflate (that is, take inflation out of ) nominal GDP to yield real GDP. Chain-Weighted Measures of Real GDP We have been discussing real GDP as if the prices used to compute this measure never change from their base-year values. If this were truly the case, over time the prices would become more and more dated. For instance, the price of com￾puters has fallen substantially in recent years, while the price of a year at college has risen.When valuing the production of computers and education, it would be misleading to use the prices that prevailed ten or twenty years ago. To solve this problem, the Bureau of Economic Analysis used to update period￾ically the prices used to compute real GDP. About every five years,a new base year was chosen. The prices were then held fixed and used to measure year-to-year changes in the production of goods and services until the base year was updated once again. In 1995, the bureau announced a new policy for dealing with changes in the base year. In particular, it now emphasizes chain-weighted measures of real GDP. With these new measures, the base year changes continuously over time. In essence, average prices in 2001 and 2002 are used to measure real growth from 2001 to 2002; average prices in 2002 and 2003 are used to measure real growth from 2002 to 2003; and so on.These various year-to-year growth rates are then put together to form a “chain” that can be used to compare the output of goods and services between any two dates. This new chain-weighted measure of real GDP is better than the more tradi￾tional measure because it ensures that the prices used to compute real GDP are never far out of date. For most purposes, however, the differences are not impor￾tant. It turns out that the two measures of real GDP are highly correlated with each other. The reason for this close association is that most relative prices change slowly over time. Thus, both measures of real GDP reflect the same thing: economy-wide changes in the production of goods and services. Nominal GDP GDP Deflator CHAPTER 2 The Data of Macroeconomics | 23