Macro4 Essay Example | Topics and Well Written Essays - 1250 words

Macro4 - Essay Example By removing inflation, real GDP allows economists to make more accurate comparisons between countries and across multiple years. For example, let us consider a scenario where Nominal GDP in year N-1 was 500 and 525 in year N. The nominal GDP has grown by 5%. Now we look at three scenarios, one where inflation is 5% (country like UK), second where inflation is 1% (country like US) and the third where inflation is 10% (developing countries like India or China). If the economic policy makers were to consider only nominal GDP, all the three policy makers might consider similar fiscal policies. However, by looking at the real GDP, we are able to see that even though nominal growth of developing countries is higher, it is still lower than the inflation rate and the real GDP would actually have dropped. The goal of economic policy makers is to have low unemployment, stable prices and to stimulate growth. They have two sets of tools for this objective: 1) Fiscal policy – Government sp ending and Taxation 2) Monetary policy – Discount rate, Bank reserve ratio, and Open market operations So, the assumption made about what policy makers want to know when considering Real GDP more meaningful is the following: a) Are economic policies creating a real increase in the output? b) How much real demand is being created by government spending and taxation policy? c) Is the monetary policy able to drive growth at constant prices? 2. Why is GDP inadequate as a measure of social welfare? Can you think of any ways to make GDP a better measure of social welfare? GDP simply adds up all the products and services that are bought and sold. It makes no distinction between transactions that ass to the social welfare and those that diminish it. GDP assumes that all monetary transactions add to well-being without separating cost from benefit. For example, as a result of the recent earthquake and Tsunami in Japan, GDP would not take into account the loss caused by it but would act ually add up the cost spent in bringing things back to normal. Also, activities that actually are negative for the social welfare are added up in GDP – like lawyer fees in divorces or property damage and medical expenses due to crime. Further, GDP does not take into account some of the most important social welfare work that happens in our everyday lives – childcare, DIY home repairs, or even voluntary work. As an example of the ambiguity of GDP, if we hire someone to do the home repairs, GDP adds the income but if we do it ourselves, the DIY repair goes â€Å"unnoticed† in the GDP. In order to make GDP a better measure of social welfare, we could represent GDP like the balance sheet of a company showing separately the assets (monetary transactions that lead to social welfare and development) and the liabilities (monetary transactions that cause negative impact on social welfare or those that have been made in order to be back to normal after a disaster). The ne t of these assets and liabilities would then be a good indicator of how much actual social welfare has occurred in the country or over time. 4. a. Compute real GDP for each year. 1987 is the base year. Show your work. Year Nominal GDP GDP deflator Real GDP 1989 5 244 1,08 4 856 1990 5 514 1,13 4 880 1991 5 672 1,17 4 848 Real GDP in Year n = Nominal GDP in Year n GDP Deflator for that year Real GDP in 1989 = 5 244 / 1.08 = 4