GDP Real vs. Nominal GDP 4 — Questions and Answers
Question 1: During a period of deflation, which of the following is true about the relationship between nominal and real GDP?
- Real GDP grows faster than nominal GDP (Correct answer)
- Nominal GDP grows faster than real GDP
- They grow at the same rate
- Real GDP always falls during deflation
Correct answer: Real GDP grows faster than nominal GDP
Deflation means prices are falling, so adjusting nominal GDP upward (dividing by a deflator less than 1) yields a higher real GDP.
Question 2: An economy's GDP deflator is 80 in year 1 and 100 in year 5 (base year). This means:
- Prices were lower in year 1 than in year 5 (Correct answer)
- Prices were higher in year 1 than in year 5
- Real GDP was higher in year 1
- Nominal GDP fell between years 1 and 5
Correct answer: Prices were lower in year 1 than in year 5
A deflator below 100 indicates price levels were lower than the base year, so year 1 had lower prices than year 5.
Question 3: Country X has nominal GDP of $500 billion and a GDP deflator of 125. Country Y has nominal GDP of $400 billion and a GDP deflator of 80. Which country has higher real GDP?
- Country X with $400B real GDP vs. Country Y's $500B real GDP — so Country Y
- Country X (Correct answer)
- They are equal
- Cannot be determined without population data
Correct answer: Country X
Country X real GDP = $500B/125×100 = $400B; Country Y real GDP = $400B/80×100 = $500B — Country Y has higher real GDP.
Question 4: Which of the following would cause nominal GDP to rise while real GDP remains flat?
- Inflation with no change in output (Correct answer)
- An increase in exports with stable prices
- A rise in labor productivity
- A decrease in the tax rate stimulating investment
Correct answer: Inflation with no change in output
Pure inflation raises the price of existing output, inflating nominal GDP without any actual increase in the volume of production.
Question 5: A student argues that a country became richer because its nominal GDP grew 8% last year. What critical information is missing?
- The inflation rate during that year (Correct answer)
- The country's trade balance
- The government deficit level
- Whether GDP was measured in dollars or euros
Correct answer: The inflation rate during that year
Without knowing the inflation rate, it is impossible to determine how much of the 8% nominal growth represents actual increases in output.
Question 6: In a two-good economy producing cars and bread, how does switching to chain-weighted real GDP help compared to fixed-base-year real GDP?
- It reduces substitution bias as relative prices of cars and bread change over time (Correct answer)
- It makes calculations simpler
- It removes the need for a base year entirely
- It weights goods by their export value
Correct answer: It reduces substitution bias as relative prices of cars and bread change over time
Chain-weighting updates the price weights each period, capturing substitution between goods as their relative prices shift, unlike a fixed base year.
Question 7: The 'price level effect' in GDP measurement refers to:
- The portion of nominal GDP growth attributable to rising prices rather than increased output (Correct answer)
- The impact of import prices on domestic production
- Seasonal adjustment of quarterly GDP
- The effect of tax policy on consumer prices
Correct answer: The portion of nominal GDP growth attributable to rising prices rather than increased output
The price level effect captures how much of nominal GDP growth comes from inflation rather than from actually producing more goods and services.
GDP Real vs. Nominal GDP 4
During a period of deflation, which of the following is true about the relationship between nominal and real GDP?