"Are you better off today than you were 4 years ago? What about 40 years ago?" These sorts of questions invite a different kind of query: what exactly do we mean,

"Are you better off today than you were 4 years ago? What about 40 years ago?" 

These sorts of questions invite a different kind of query: what exactly do we mean, when we say “better off?” And more importantly, how do we know if we’re better off or not?

To those questions, there’s one figure that can shed at least a partial light: real GDP.

In the previous video, you learned about how to compute GDP. But what you learned to compute was a very particular kind: the nominal GDP, which isn’t adjusted for inflation, and doesn’t account for increases in the population.

A lack of these controls produces a kind of mirage.

For example, compare the US nominal GDP in 1950. It was roughly $320 billion. Pretty good, right? Now compare that with 2015’s nominal GDP: over $17 trillion.

That’s 55 times bigger than in 1950!

But wait. Prices have also increased since 1950. A loaf of bread, which used to cost a dime, now costs a couple dollars. Think back to how GDP is computed. Do you see how price increases impact GDP?

When prices go up, nominal GDP might go up, even if there hasn’t been any real growth in the production of goods and services. Not to mention, the US population has also increased since 1950. 

As we said before: without proper controls in place, even if you know how to compute for nominal GDP, all you get is a mirage.

So, how do you calculate real GDP? That’s what you’ll learn today.

In this video, we’ll walk you through the factors that go into the computation of real GDP.

We’ll show you how to distinguish between nominal GDP, which can balloon via rising prices, and real GDP—a figure built on the production of either more goods and services, or more valuable kinds of them. This way, you’ll learn to distinguish between inflation-driven GDP, and improvement-driven GDP.

Oh, and we’ll also show you a handy little tool named FRED —  the Federal Reserve Economic Data website.

FRED will help you study how real GDP has changed over the years. It’ll show you what it looks like during healthy times, and during recessions. FRED will help you answer the question, “If prices hadn’t changed, how much would GDP truly have increased?”

FRED will also show you how to account for population, by helping you compute a key figure: real GDP per capita. Once you learn all this, not only will you see past the the nominal GDP-mirage, but you’ll also get an idea of how to answer our central question:

"Are we better off than we were all those years ago?"

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Show 1 Answer (Answer provided by Ion Sterpan)
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Imagine accounting as noting down your payments and your revenues. Every firm has such a balance sheet. Accounting is necessary for economic decision making. Payments, sometimes called “accounting costs” are not what economists call “costs”. If I inherit a piece of land, and use it in a business, my balance of payments will show I paid nothing for that piece of land. However, the economic cost is not zero. The decision of keeping using the land for this business has an opportunity cost. I could sell or rent the land to someone else. The gain I forego from that sale is a lost opportunity. (I can ask myself, is that scenario or opportunity which I do not take, more valuable to me than the scenario I am now in?) The value of that lost opportunity is called economic cost, or opportunity cost. So much about economic principles. Macroeconomic principles are economic principles, so they must be concerned with economic costs. But unlike accounting, which is an activity that pertains to firms or organizations which have payments going out and and revenues coming in, macroeconomics is concerned with aggregate value across a network of firms and other organizations. These aggregate values can measure average price level, total unemployment, economic growth rate, population growth rate and so on.

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Great question, Yousra! Yes, when we've published the full course, you can receive a Marginal Revolution University certificate upon satisfactory completion of the final exam.

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I am not sure exactly which videos or statements you are referencing. Exports are added in because some of the things we export were produced here. This category is generally distinct from the consumption, investment, or government purchases categories (when you buy a consumption good, it will not also be an export). Thus exports are not ALREADY counted, but they do need to be counted.

Imports are a little different. Most students think that we subtract imports simply "because they were not made here", but there are plenty of things made in other countries that we do not subtract when calculating GDP. Think about the things you consume. Some of them were made domestically, and some were imported. The same is true of investment, government purchases, and even some things we export; some of it was made here, and some was not. Because the point in calculating GDP is to find the value of only the domestically produced goods and services, it is a little bit of a problem that when we add up consumption, investment, government purchases, and exports that some of that was not actually produced domestically. Thus we subtract off imports to remove these foreign-produced goods that were erroneously added in earlier.

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Hi Mani,
Alex Tabarrok is in India for the next few months and we're planning on shooting some videos about India's economy while he's there.
Cheers,
Meg

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