Cambridge International as and a level Economics Ebook

SELF-ASSESSMENT TASK 
9.3
 
Which of the following should be included in 
measuring GDP by the income method:
■ 
government subsidies to farmers
■ 
the pay of civil servants
■ 
the pay of nurses
■ 
supernormal profi ts
■ 
state pensions?
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Chapter 9: The macroeconomy 

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TOP TIP
One way of remembering the three methods is to think 
about the circular flow (see later in this chapter).
Money and real GDP
Money (or nominal) GDP
is GDP measured in terms of the 
prices operating in the year in which output is produced. It 
is sometimes referred to as GDP at current prices and is a 
measure that has not been adjusted for infl ation.
Money GDP may give a misleading impression of how 
well a country is performing. Th
is is because the value of 
money GDP may rise not because more goods and services 
are being produced but merely because prices have risen. 
For example if 100 billion products are produced at an 
average price of $5, GDP will be $500 billion. If in the next 
year the same output of 100 billion products is produced 
but the average price rise to $6, money GDP will rise to 
$600 billion. So to get a truer picture of what is happening 
to output, economists convert money into 
real GDP
. Th
ey 
do this by measuring GDP at constant prices, meaning 
the prices operating in a selected year. By doing this they 
remove the distorting eff ect of infl ation. For example, in 
2016 a country’s GDP is $800 billion and the price index 
is 100. Th
en in 2017, money GDP is $900 billion and the 
price index is 120.
Real GDP
money GDP price index in base year
price index in 
=
×
ccurrent year
So $900 billion
100
120
$750 billion
×
=
Th
e price index used to convert money into real GDP is 
called the GDP defl ator, which measures the prices of 
products produced rather than consumed in a country. So 
it includes the prices of capital goods as well as consumer 
products and includes the price of exports but excludes the 
price of imports.