Worth: Mankiw Economics 5e Conomy can satisfy the demands of households, firms, and the government. If prices doubled without any change in quantities, GDP would double. Yet it would be misleading to say that the economy's ability to satisfy demands has doubled, because the quantity of every good produced remains the same Econ- omits call the value of goods and services measured at current prices nomina GDP A better measure of economic well-being would tally the economy's output of goods and services and would not be influenced by changes in prices. For this purpose, economists use real GDP, which is the value of goods and services measured using a constant set of prices. That is, real GDP shows what would have happened to expenditure on output if quantities had changed but prices had not To see how real GDP is computed, imagine we wanted to compare output in 2002 and output in 2003 in our apple-and-orange economy We could begin by hoosing a set of prices, called base-year prices, such as the prices that prevailed in 2002. Goods and services are then added up using these base-year prices to value the different goods in both years. Real GDP for 2002 would be Real gDp=(2002 Price of Apples X 2002 Quantity of Apples) +(2002 Price of Oranges X 2002 Quantity of Oranges) Similarly, real GDP in 2003 would be Real gDp=(2002 Price of Apples X 2003 Quantity of Apples) +(2002 Price of Oranges X 2003 Quantity of Oranges) And real GDP in 2004 would be Real gdp=(2002 Price of Apples X 2004 Quantity of Apples) +(2002 Price of Oranges x 2004 Quantity of oranges) Notice that 2002 prices are used to compute real GDP for all three years. Because he prices are held constant, real GDP varies from year to year only if the quanti- ties produced vary. Because a society's ability to provide economic satisfaction for its members ultimately depends on the quantities of goods and services produced, real GDP provides a better measure of economic well-being than nominal GDP The GdP Deflator From nominal GDP and real GDp we can compute a third statistic: the gdp de fator. The GDP deflator, also called the implicit price deflator for GDP, is defined as the ratio of nominal gdp to real gDp Nominal GDP DP Deflator Real GDP The GDp deflator reflects what's happening to the overall level of prices in the economy To better understand this, consider again an economy with only one good, bread. If P is the price of bread and Q is the quantity sold, then nominal gDP is User JOENA: Job EFF01418: 6264_cho2: Pg 22: 24940#/eps at 1009 Illl Tue,Feb12,20028:404MUser JOEWA:Job EFF01418:6264_ch02:Pg 22:24940#/eps at 100% *24940* Tue, Feb 12, 2002 8:40 AM economy can satisfy the demands of households, firms, and the government. If all prices doubled without any change in quantities, GDP would double.Yet it would be misleading to say that the economy’s ability to satisfy demands has doubled, because the quantity of every good produced remains the same. Econ￾omists call the value of goods and services measured at current prices nominal GDP. A better measure of economic well-being would tally the economy’s output of goods and services and would not be influenced by changes in prices. For this purpose, economists use real GDP, which is the value of goods and services measured using a constant set of prices.That is, real GDP shows what would have happened to expenditure on output if quantities had changed but prices had not. To see how real GDP is computed, imagine we wanted to compare output in 2002 and output in 2003 in our apple-and-orange economy. We could begin by choosing a set of prices, called base-year prices, such as the prices that prevailed in 2002. Goods and services are then added up using these base-year prices to value the different goods in both years. Real GDP for 2002 would be Similarly, real GDP in 2003 would be And real GDP in 2004 would be Notice that 2002 prices are used to compute real GDP for all three years. Because the prices are held constant, real GDP varies from year to year only if the quanti￾ties produced vary. Because a society’s ability to provide economic satisfaction for its members ultimately depends on the quantities of goods and services produced, real GDP provides a better measure of economic well-being than nominal GDP. The GDP Deflator From nominal GDP and real GDP we can compute a third statistic: the GDP de- flator. The GDP deflator, also called the implicit price deflator for GDP, is defined as the ratio of nominal GDP to real GDP: GDP Deflator = . The GDP deflator reflects what’s happening to the overall level of prices in the economy. To better understand this, consider again an economy with only one good, bread. If P is the price of bread and Q is the quantity sold, then nominal GDP is Nominal GDP Real GDP Real GDP = (2002 Price of Apples × 2004 Quantity of Apples) + (2002 Price of Oranges × 2004 Quantity of Oranges). Real GDP = (2002 Price of Apples × 2003 Quantity of Apples) + (2002 Price of Oranges × 2003 Quantity of Oranges). Real GDP = (2002 Price of Apples × 2002 Quantity of Apples) + (2002 Price of Oranges × 2002 Quantity of Oranges). 22 | PART I Introduction