Suppose there are J goods and services at any time t In year

Suppose there are J goods and services at any time t. In year t, a good or service j is supplied at quantity Qjt and can be purchased at Pjt which denotes its unit price at market value. Nominal GDP is the total value of domestically supplied goods and services by the economy during a given vear. Hence. it is defined as NGDP : 4 PtQjt. a. Derive the growth rate of nominal GDP. How does it relate to the growth rates of the prices and quantities of each individual good/service j? Hint. Take the derivative with respect to time t and construct the growth rate of nominal GDP. b. Argue why nominal GDP is neither a good measure to assess the growth of living standards nor the productive capacity of an economy over time.

Solution

(a)NGDP=[ (value of NGDP of final year divide by value of NGDP of the initial year or last year) to the power 1 divide by t - 1] *100. The primary use of nominal GDP is to measure between years. It is also used to find the growth or decrease in output between years with inflation or deflation included.

(b)Nominal GDP is calculated using current prices. This reduces the usefulness of the concept of as a tool for comparing the performances of the economy over time if prices are changing.Suppose that between 2012 and 2017 output has stayed unchanged while all prices have doubled in value. In that case, GDP in the latter year will be twice as high as in the former. But this gain in GDP is illusory, created entirely by the change in the prices with no change whatsoever in the availability of goods and services to the consumers.