Time to get your hands dirty with real GDP calculations! We'll work with a simple mini-economy to see how economists actually measure economic growth.

Engagement Message

Imagine an economy that only produces apples and oranges. Which two fruits power our mini-economy?

Let's start with Nominal GDP - this measures output using current year prices. Here's our mini-economy data:

Year 1: 100 apples at $2 each, 50 oranges at $3 each
Year 2: 110 apples at $2.50 each, 60 oranges at $3.50 each

Engagement Message

What's the first step to calculate Year 1's nominal GDP?

For Year 1 nominal GDP: (100 × $2) + (50 × $3) = $200 + $150 = $350

For Year 2 nominal GDP: (110 × $2.50) + (60 × $3.50) = $275 + $210 = $485

Engagement Message

Nominal GDP grew from $350 to $485. Did GDP rise because of higher quantities, higher prices, or both?

Here's the problem: nominal GDP can rise just because prices went up, not because we actually produced more stuff!

To see real economic growth, we need Real GDP - which uses constant prices from a chosen base year.

Engagement Message

Which year should we use as our base year for comparison?

Let's use Year 1 as our base year. Real GDP always uses base year prices, so:

Year 1 Real GDP: (100 × $2) + (50 × $3) = $350 (same as nominal)
Year 2 Real GDP: (110 × $2) + (60 × $3) = $220 + $180 = $400

Engagement Message

Now we see the real growth: from $350 to $400. Much more realistic! By how many dollars did real GDP increase from Year 1 to Year 2?

The GDP Deflator helps us measure how much prices changed. It's calculated as: