3 a) Explain the process by which nominal GDP is calculated and distinguish it from real GDP.
Economists wish to determine the actual level of output of goods and services produced in a year. “Nominal GDP is the value of goods and services produced in a country in a given year, which is expressed in the value of the prices charged for that year.” The nominal GDP is calculated by counting the percent or price increase/decrease of a good/service in the national income. Thus, a nominal GDP results the GDP to be overestimated as it presents us into thinking the economy is doing better than it really is. In short: when the price level increases (inflation), nominal GDP exaggerates the value of output compared to the real output. When the price level decreases (deflation), nominal GDP underestimates the value of real output compared to the actual output. This nominal differs from real GDP, as the real GDP measures the output and factors out the price changes, which shows a more accurate measure of the true output from one year to another. Economists hope to determine the difference between the nominal and real GDP in order to calculate the ‘real output’.
b) To what extent do measures of GDP accurately estimate national well-being?
GDP (Gross Domestic Product) enables us to broadly distinguish the countries quality of life (welfare). It can be assumed that, ceteris paribus, “more income is better than less income” and the ranking of the income levels according to the per capita could be ranked in the same order for welfare. Yet GDP could have some flaws in which it masks the country’s true welfare. Economists observed that the national income accounting sometimes exaggerates or underestimates well-being which could en d up in an unpredictable way.
GDP is overestimated due to adding clearly negative social behaviors and transactions as net positives for GDP as well as under-reporting the loss of natural resources. Negative social behaviors include money spent to jail criminals, fight wars, and consumption of unhealthy products being added to the GDP. The destruction of endangered species and degradations of rainforests would be counted as increased production than damaging the valuable resource base.
GDP underestimates well-being because: the fact that people are living longer, the black/underground market activity, and unpaid output are all not included. Longer life-expectancy is something all countries strive to have and yet GDP cannot measure this factor. Some countries have high quantities of black markets yet these market’s income is not calculated into the GDP. Also, volunteer works are not counted in the GDP as well since it only calculates paid work and thus some countries seem to be poorer than they really are. ALso, the GDP adds market transactions, regardless of the quantity of output. The improvements in technology is unseen in GDP although it could have improved the quality and safety of the goods/services.
GDP also lacks information in these ways: the composition of the output is a mystery, GDP doesn’t measure many aspects of the quality of life, it provides no information about the distribution of income, and it does not account for purchasing power.