Essay: Nominal and Real Values

1) Explain the difference between a nominal value and a real value.

Answer: A nominal value is the actual price that is paid or the actual wage received. If today you

pay $1 for a can of Pepsi, this amount is a nominal value. A real value is adjusted for

changes in the price level. To compare prices or wages across years, the nominal values

need to be converted to real values. In other words, you need to compare values in the

same dollars. This conversion is necessary because a dollar today is not worth the same

as a dollar 20 years ago.

Topic: Nominal and real values

Skill: Level 2: Using definitions

Section: Checkpoint 7.3

Status: Old

AACSB: Written and oral communication

2) When the nominal price of a good increases over time, must its real price also increase?

Answer: No, even though the nominal price of a good increases, its real price might decrease. For

instance, the nominal price of motorcycles has increased between 1970 and 2010, but

their real price has decreased because the CPI increased even more rapidly.

Topic: Nominal and real values

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Written and oral communication

3) What is the difference between nominal variables and real variables? Discuss the calculations

undertaken to determine the real wage rate and the real interest rate. Explain why the real

wage rate and real interest rate are real variables.

Answer: Nominal variables are measured using current dollars; real variables are measured

using dollars of a given base year. More generally, nominal variables are in terms of

current dollars whereas real variables are in terms of the quantity of goods and services

that can be purchased. The real wage rate equals the nominal wage rate divided by the

CPI. The real interest rate equals the nominal interest rate minus the inflation rate. The

real wage rate is a real variable because it provides the purchasing power of an hourʹs

labor. The real interest rate is a real variable because it provides the purchasing power

gained as interest on a loan.

Topic: Nominal and real values

Skill: Level 5: Critical thinking

Section: Checkpoint 7.3

Status: Old

AACSB: Written and oral communication

4) In 1995, the CPI was 152.5 and the price of an economics textbook was $70.00 and a music CD

was $16.00. If the CPI was 172.3 in 2011, what were the prices of the economics textbook and

the music CD in 2011 dollars?

Answer: To adjust the two prices, the ratio of the CPI in 2011 to the CPI in 1995 is needed. This

ratio is (172.3)/(152.5) = 1.13. Then multiply the 1995 prices by this ratio to convert the

prices to 2011 dollars. This yields a 2011 dollar price for the textbook of ($70.00 × 1.13) =

$79.10 and a 2011 dollar price for the CD of ($16.00 × 1.13) = $18.08.

Topic: Money values at different dates

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

5) In 1979, the price of gasoline was $1.389 per gallon and the CPI was 72.6. In 2003, the price of

gasoline was $1.589 per gallon and the CPI was 182.9. Find the real price of gasoline in 1979

and 2003 in terms of base period dollars.

Answer: To adjust the price in 1979, the ratio of the CPI in the base period to the CPI in 1979 is

needed. The base period CPI is 100, so this ratio is (100)/(72.6) = 1.38. Then multiply the

1979 price by this ratio to convert the price to base period dollars, which yields a base

period price for the gallon of gasoline of ($1.389 per gallon × 1.38) = $1.92 per gallon.

To adjust the price in 2003, a similar procedure is followed. The ratio of the CPI in the

base period to the CPI in 2003 is (100)/(182.9) = 0.55. Then multiply the 2003 price by

this ratio to covert the price to base period dollars, which yields a base period price for

the gallon of gasoline of ($1.589 per gallon × 0.55) = $0.87 per gallon.

Topic: Money values at different dates

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

6) Scott worked in a large foreign country. He retired in 2008 and his pension income is fixed at

$1,500 per month. The table above gives the CPI in this country. What is the real monthly

value of his pension in the years between 2008 and 2011?

Answer: To calculate the real value of the pension, divide the $1,500 pension by the CPI and then

multiply by 100. This calculation gives the real values as: 2008, $1,500.00; 2009,

$1,463.41; 2010, $1,415.09; 2011: $1,351.52.

Topic: Money values at different dates

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

7) For each of the following values of nominal GDP and real GDP, calculate the GDP price index.

a. Nominal GDP = $600; real GDP = $800.

b. Nominal GDP = $900; real GDP = $900.

c. Nominal GDP = $1,200; real GDP = $1,000.

Answer: a. The GDP price index equals ($600 ÷ $800) × 100, which is 75.

b. The GDP price index equals ($900 ÷ $900) × 100, which is 100.

c. The GDP price index equals ($1,200 ÷ $1,000) × 100, which is 120.

Topic: Real GDP and nominal GDP

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

8) If nominal GDP is $230 for a period and real GDP is $200 for the same period, what is the GDP

price index for this period?

Answer: The GDP price index equals 115, or (100) × ($230 ÷ $200).

Topic: Real GDP and nominal GDP

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

9) The table above has real and nominal GDP for two years for a foreign country.

a. What does the GDP price index equal in 2010? What does the value of the GDP price index

tell you about 2010?

b. What does the GDP price index equal in 2011?

Answer: a. The GDP price index equals (100) × (nominal GDP ÷ real GDP). In 2010, the GDP

price index equals (100) × ($3,300 trillion ÷ $3,300 trillion) = 100. Because the GDP price

index equals 100, we can determine that 2010 is a base year.

b. In 2011, the GDP price index equals (100) × ($4,200 ÷ $3,600) = 116.67.

Topic: Real GDP and nominal GDP

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Analytical thinking

10) Explain how the nominal wage rate is converted into the real wage rate. Explain why this

process of conversion changes the nominal wage rate into the real wage rate.

Answer: The real wage rate equals the nominal wage rate divided by the CPI. The nominal wage

rate equals the dollars that are paid for an hourʹs labor. The CPI is a measure of the

prices of the goods and services that the typical consumer purchases. Hence dividing

the number of dollars for an hourʹs labor by the prices for the goods and services

purchased gives, as its result, the number of goods and services that can be purchased

by the hourʹs labor.

Topic: Nominal and real wage rates

Skill: Level 3: Using models

Section: Checkpoint 7.3

Status: Old

AACSB: Written and oral communication

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