EC212 · LESSON 03 / 08

3. Real GDP, prices, and inflation

Sales revenue rises 20%, but prices also rise. How can we separate extra output from higher prices?

Understand

What is this lesson explaining?

Nominal GDP uses current prices. Fixed-base real GDP values current quantities at base-year prices, isolating quantity changes. The GDP deflator is their ratio multiplied by 100.

A basic CPI compares the cost of a consumer basket with its base-year cost. The GDP deflator covers domestic production. Imported consumer goods may enter CPI but are not domestic GDP.

KEY MODEL

Deflator = 100 × nominal GDP / real GDP

π = 100 × (P₁ − P₀) / P₀

P₀, P₁Previous and current price indicesπInflation rate in percent per period

See it on a graph

The graph is right here

Read the axes and original point first. Then change one value at a time and watch the curve or point move.

Separate more output from higher pricesReal GDP = Nominal GDP ÷ price index

Quick check

NO TYPING

CPI rises from 125 to 130. What is inflation?

Takeaway

Remember these two ideas

✓

The base year produces 100 units at 10 each. The new year produces 110 units at 12: new nominal GDP is 1,320, but real GDP is 1,100.

Common mix-upA five-point index increase is not necessarily 5% inflation; divide by the previous index.

Assumptions and sources

The example uses one good and fixed base-year prices, not more complex chain weighting.

EC212 tutoring outline: chapters 1–8 (local course outline)
Mankiw, Macroeconomics, 8th edition, chapter 2, pp. 24–25, 32–33