Below are some data from the land of milk and honey.

Year Price of Milk Quantity of Milk Price of Honey Quantity of Honey

2016 $1 100 quarts $2 50 quarts

2017 1 200 2 100

2018 2 200 4 100

a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2016 as the base year.

b. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2017 and 2018.

The solution to the given problem is done below.

Explanation:

a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2016 as the base year.

Nominal GDP is simply equal to the sum of the current year price * current  year quantity of all the goods.

2016: ($1 per qt. of milk X 100 qts. milk) + ($2 per qt. of honey X 50 qts. honey) = $200

2017: ($1 per qt. of milk X 200 qts. milk) + ($2 per qt. of honey X 100 qts. honey) = $400

2018: ($2 per qt. of milk X 200 qts. milk) + ($4 per qt. of honey X 100 qts. honey) = $800

Calculating real GDP (base year 2016):

Real GDP is equal to the sum of the base year price * current year quantity of  all the goods.

Calculating real GDP (base year 2016):

2016: ($1 per qt. of milk X 100 qts. milk) + ($2 per qt. of honey X 50 qts. honey) = $200

2017: ($1 per qt. of milk X 200 qts. milk) + ($2 per qt. of honey X 100 qts. honey) = $400

2018: ($1 per qt. of milk X 200 qts. milk) + ($2 per qt. of honey X 100 qts. honey) = $400

b. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2017 and 2018.

Percentage change in nominal GDP in 2017 = [($400 –$200)/$200] X 100% = 100%.

Percentage change in nominal GDP in 2018 = [($800 –$400)/$400] X 100% = 100%.

Percentage change in real GDP in 2017 = [($400 –$200)/$200] X 100% = 100%.

Percentage change in real GDP in 2018 = [($400 –$400)/$400] X 100% = 0%.

The GDP deflator is equal to (Nominal GDP / Real GDP)*100

Percentage change in the GDP deflator in 2017 = [(100 –100)/100] X 100% = 0%.

Percentage change in the GDP deflator in 2018 = [(200 –100)/100] X 100% = 100%.

Prices did not change from 2016 to 2017. Thus, the percentage change in the GDP deflator is zero. Likewise, output levels did not change from 2017 to 2018. This means that the percentage change in real GDP is zero.