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One number for the size of an economy — and three completely different ways of measuring it that all have to give the same answer. Get this straight now and the whole course gets easier.
Macroeconomics is the study of the economy as a whole. Not one firm, not one market — everything at once.
To do that you need to compress a whole country into a handful of numbers. This course starts with three of them:
Those numbers come from the NATIONAL ACCOUNTS, which measure the economic activity in a country.
They are compiled according to international guidelines, defined by the United Nations System of National Accounts. In the Netherlands the Centraal Bureau voor de Statistiek (CBS) does the work.
The rules were first written in 1953, with major revisions in 1968, 1993 and 2008.
The 2008 edition runs to 722 pages. Measuring a country is not a casual exercise.
The most important aggregate measure of economic activity is GROSS DOMESTIC PRODUCT (GDP).
The course asks three questions about it:
The total value of all final goods and services produced in an economy during a given period.
Read that definition slowly — four of its words are doing real work.
The same GDP has two more definitions, which sound like different things entirely:
Each definition gives a way of actually measuring the number:
Three approaches, one number. That is not a coincidence, and it is not an approximation. It has to hold.
A baker sells €5 of bread. Where does the €5 show up in each of the three approaches?
PRODUCTION. A loaf worth €5 came into the world. Production: €5.
INCOME. The €5 the baker received did not evaporate. It paid wages, rent, interest — and whatever is left over is the baker's own profit. Income: €5.
EXPENDITURE. Someone handed over €5 at the counter. Expenditure: €5.
The same €5, counted at three different stations on its journey. Production creates it, income distributes it, expenditure spends it.
The three approaches are three places to stand while the same euro walks past you.
MADE → EARNED → SPENT. Count it once, at any one of the three.
GDP is a FLOW, not a stock. It is production per period — per year, per quarter.
Wealth is a stock: what a country owns at one moment. GDP is a rate: what it produces per unit of time.
A question that asks "GDP in 2024" is asking about everything produced during that year, not about what the Netherlands was worth on 31 December.
The income approach. It measures the same GDP, from the side of whoever ended up receiving the money.
Add up what the country made. The trap is double counting — and the fix, value added, is also the definition that separates GDP at market prices from GDP at basic prices.
Production of final goods and services, valued at market prices. p_i is the price of good i, q_i the quantity of good i.
Because everything is valued at the price it actually sells for, this number is sometimes called GDP AT MARKET PRICES.
What if a market price is not available?
So if you cook dinner at home, it is not in GDP. Pay a restaurant to cook the same dinner, and it is.
That is a known weakness of the measure, not a mistake in it.
Only the value of FINAL goods and services counts. Not the value of intermediate goods and services.
A farmer sells €1 of wheat to a miller. The miller sells €3 of flour to a baker. The baker sells €5 of bread to you. What is GDP?
Adding up every sale gives €1 + €3 + €5 = €9. That is wrong.
The wheat is inside the flour, and the flour is inside the bread. Counting all three counts the wheat three times.
Only the bread is FINAL — nobody uses it to make something else.
GDP = €5.
But there is a second route to the same €5, and it is the one statistics offices actually use — because nobody can phone every firm and ask whether its output was final.
Each firm reports what it sold minus what it bought in. That difference is its VALUE ADDED.
Total: 5. The same answer, with no judgement about which goods were final.
The practical implementation of the production approach. VA_i is the value added by sector i.
Why the extra term? Value added is measured from what the firm receives, and the firm does not keep the VAT.
Adding taxes less subsidies on products back on is what turns a sum of value added into GDP at the prices buyers actually pay.
GDP at basic prices = GDP at market prices − taxes less subsidies on products.
Most taxes on products are value added taxes (VAT).
BASIC prices are what the producer receives. MARKET prices are what the buyer pays. The gap between them is the tax.
Market = Basic + taxes on products. The buyer always pays more.
€3,000 — the value added. The €20,000 car was already counted when it was produced; the dealer's contribution is the service of getting it to you.
GDP measured from the receiving end. The exam has twice asked the same question about this table, and both times the answer turned on one line of it: mixed income.
Every euro a firm receives goes somewhere. Wages to workers, interest to lenders, rent to landlords, profit to owners.
Add up all of it and you have GDP again — measured from the income side.
GDP at factor cost = GDP at market prices − taxes less subsidies on production and imports.
Most taxes on production are value added taxes (VAT).
GDP at factor cost is what gets distributed among the FACTORS OF PRODUCTION: capital and labour.
But labour income and capital income are very difficult — or impossible? — to measure accurately.
The problem is the self-employed. A plumber working alone earns money partly by WORKING and partly from OWNING the van and the tools.
No payslip splits that. So the national accounts do not try.
The income approach in the National Accounts:
GDP = Compensation of employees + Operating surplus + Mixed income + Taxes less subsidies on production and imports
What each line is:
Mixed income is the un-splittable middle. It is why the exam can never let you say labour income is exactly the compensation of employees.
Labour income = compensation of employees + SOME mixed income → so labour income is MORE than compensation of employees. Capital income = operating surplus + SOME mixed income → so capital income is LESS than operating surplus + mixed income.
The composition of GDP in Japan in 2016, income approach (in percent):
Are the following statements true or not true?
I. Capital income was 41.8% of GDP at market prices. II. GDP at factor prices was 91.8% of GDP at market prices.
Before touching the numbers, notice that the table hands you operating surplus and mixed income GLUED TOGETHER as one line.
That is the whole question. Any statement that treats 41.8 as pure capital income, or as pure anything, is walking into the trap.
Statement II is a definition question, not a measurement one: does factor cost mean what you think it means?
STATEMENT I. Capital income is the operating surplus plus PART of mixed income — the rest of mixed income is labour income.
So capital income is less than operating surplus plus ALL of mixed income, and therefore less than 41.8%. Statement I is NOT true.
STATEMENT II. GDP at factor cost is capital income plus labour income — which together are exactly compensation of employees plus operating surplus and mixed income.
Do not confuse the two subtractions. They strip out different taxes.
Basic prices belong to the production approach, factor cost to the income approach.
GDP at factor cost = 55 + 30 + 5 = 90, or equivalently 100 − 10.
Labour income is more than 55 and less than 60: the compensation of employees plus an unknown part of the 5 of mixed income.
GDP measured by who bought the stuff. This is the version every model in the course uses — C + I + G + NX starts life here, as an accounting identity.
GDP = Final consumption expenditures + Gross capital formation + Net exports (the trade balance)
Each of the three splits further:
In plain terms: households buying, government buying, firms buying things they will produce with, and foreigners buying more from us than we buy from them.
Why subtract imports? Because the other three lines already include them.
A Dutch household buying a German car adds to consumption but nothing was produced here. Subtracting imports cancels exactly that.
Three notes on that list. All three are exam material.
The inventory note is the strange one. A firm produces 100 cars and sells 90. Who bought the other ten?
The accounts say the firm's owners did. Production happened, so somebody must have spent — so the unsold stock is booked as expenditure by the owners.
That convention is what keeps the three approaches equal by construction. Production always equals expenditure, because anything unsold is counted as bought by the producer.
A state pension, unemployment benefit or child allowance is NOT government consumption.
The government is not buying anything with a transfer payment — it is moving money to a household, which then does the buying. Counting both would count it twice.
Same logic for financial assets: buying a share is a change of ownership, not new production. Only the fee charged by whoever arranged the trade is a service that counts.
GDP counts NEW THINGS MADE. Anything that only moves money or ownership around — transfers, shares, second-hand goods — is not in it.
This is the approach every model in the course is built on. In theory the four categories get one letter each:
Lecture 3 sets that up properly. For now, notice it is nothing more than the expenditures approach with short names.
(a) No — a transfer payment. (b) Yes — gross fixed capital formation. (c) No — a purchase of a financial asset. Any broker's fee is, since that is a service produced. (d) Yes — inventory investment, booked as expenditure by the bakery's owners.
Did the country produce more this year, or did prices just go up? Splitting those apart is what real GDP is for — and the split is not as clean as it first looks.
Nominal GDP in period is GDP where the produced quantities in period are valued at the prices of period — that is, at current prices:
Nominal GDP changes over time as quantities change AND/OR as prices change.
So the growth rate of nominal GDP is not a good measure of how produced quantities change over time.
An economy that produces exactly the same goods as last year, at prices 10% higher, has 10% more nominal GDP. Nobody produced anything extra.
The fix: value this year's quantities at OLD prices. If the prices never move, any change left in the number must come from quantities.
Real GDP in period is GDP where the produced quantities in period are valued at the prices of a BASE period (say period 0):
Notation: the superscript denotes the base year. is real GDP in year 2, valued at the prices of year 1.
Note what did NOT change: the quantities. Those are always this period's. Only the price tags are frozen.
Why value at prices at all, rather than just adding up quantities?
Because adding quantities gives a cheap good the same weight as an expensive one. Prices are what make the weights sensible.
Two warnings come with the method:
The first warning sounds like a technicality. It is not. Change the base year and the growth rate can change sign.
An economy produces two goods.
Year 1: at price 10, at price 5. Year 2: at price 12, at price 3.
Why the two disagree: good 2 collapses from 8 to 4. At year-1 prices good 2 is cheap-ish (5 against 10) but there is a LOT of it, so its fall dominates.
At year-2 prices the rise in good 1 is valued at 12, which is enough to offset it exactly.
The level of real GDP also depends on the base year — the lower the base-year prices, the lower the level.
That is not really a problem: we are generally not interested in the LEVEL of real GDP, but in its GROWTH RATE.
Unfortunately the growth rate depends on the base year too. So which base year should you choose?
There is no good choice. That is what the next topic fixes.
Real GDP in year with base year : quantities from , prices from . The superscript is always the year whose PRICES you borrowed.
— the letter downstairs is what you count, the letter upstairs is what you pay.
Real GDP in the base year equals NOMINAL GDP in the base year. Every time.
and nominal GDP in year 1 is also : same quantities, same prices.
— which is , real GDP in year 2 at year-2 prices. The base year is the one year where nominal and real coincide.
Stop picking a base year and average the two answers instead. Three steps, one shortcut the exam explicitly allows, and a numerical question that has appeared on every paper.
The previous topic ended in a dead end: base year 1 says −20%, base year 2 says 0%, and there is no reason to prefer either.
Most of the time there is no obvious reason for preferring year 1 rather than year 2, or the other way round.
So a logical way to proceed is to compute real GDP growth with year 1 as base year, then with year 2 as base year, and take the AVERAGE of both growth rates.
The recipe, in three steps. To get the growth rate of chain-weighted real GDP between and :
1. Compute the growth rate of real GDP between and at constant prices of period . 2. Compute it again at constant prices of period . 3. Take the average of both growth rates.
If the two growth rates are small compared to 1, the geometric mean is approximately the arithmetic one:
Homework 1 states the rule as an instruction: APPROXIMATE A GEOMETRIC MEAN BY THE ARITHMETIC MEAN.
The same note is printed on the numerical section of every past paper.
So in this course: add the two growth rates and halve. No square roots in the exam.
chain growth = (g¹ + g²) / 2
That gives you a GROWTH RATE. To get LEVELS, two more steps:
Walking forward means multiplying by . Walking BACKWARD means dividing by it:
The payoff: the growth rate of chain-weighted real GDP does NOT depend on the choice of the base period.
The base period only decides where the chain of levels is nailed down.
An economy produces two goods.
Year 1: at price 10, at price 12. Year 2: at price 15, at price 4.
here, and that is a coincidence of the numbers, not a rule.
The rule that always holds is the other one: equals nominal GDP in year . So is nominal GDP in year 1, and is nominal GDP in year 2.
The order the exam asks for the nine numbers is the order you should compute them. Work down the list and never jump.
Prices of year 1 → two levels → one growth rate. Prices of year 2 → two levels → one growth rate. Average them. Anchor at nominal. Grow once.
Dutch GDP is in euros, American GDP is in dollars. Converting at the market rate is the obvious move and the wrong one — here is the method the World Bank uses instead, in five steps you can do in two minutes.
In 2024, GDP in the U.S. was $29184 billion and GDP in the Netherlands was €1134 billion.
To compare them, both have to be expressed in ONE currency.
Bad idea: use market exchange rates.
The second objection is the deeper one. In poor countries, goods and services that are not traded internationally are relatively cheap; in rich countries the same ones are often much more expensive.
That is why Mexicans travelling to the U.S. prefer to have their hair cut in Mexico before they leave, and why Dutch people on a diet of expensive broodje-kroket sandwiches at home eat sumptuously on holiday in less prosperous countries.
A haircut cannot be shipped. So its price never gets equalised across borders, and the exchange rate has no reason to reflect it.
Converting at market rates therefore UNDERSTATES what a poor country's GDP actually buys.
Better idea: the World Bank's methodology. If you want the full version it is 659 pages. The essence is a simple example.
The method, in five steps.
1. Take a benchmark country — economists usually choose the U.S. 2. Split its whole year's production into many identical tiny baskets, each worth exactly one dollar. 3. Introduce a fictitious currency, the INTERNATIONAL DOLLAR (I$), and assume I$1 buys exactly one of those baskets. 4. Work out what that same basket costs in the other country, in its own currency. 5. Divide the other country's GDP by that price.
Step 3 is the one that feels like a trick. It is really a definition: I$1 is DEFINED as the purchasing power of $1 in the U.S.
So U.S. GDP in I$ is numerically the same as U.S. GDP in $. Nothing is converted.
Sanity check on that formula: price the basket at U.S. prices and you must get exactly one dollar back. If you do not, the division went wrong.
In the 2024 figures, €0.748 buys what I$1 buys. So Dutch GDP of €1134 billion, divided by €0.748 per international dollar, is I$1516 billion — and THAT is the number to compare with the U.S.
GDP measured this way is called GDP at PURCHASING POWER PARITY (PPP).
Two countries, two goods.
Netherlands: at €0.50, at €1.50. U.S.: at $2, at $3.
The last step is a division, and students reliably multiply instead. Think about the units.
euros ÷ (euros per I$) = I$. The euros cancel. If your answer still has a euro sign on it, you multiplied.
The basket is built from the BENCHMARK country's quantities only. The other country's quantities never enter it.
Dutch quantities appear exactly once in the whole exercise: in Dutch nominal GDP. Dutch PRICES appear twice — there, and in pricing the basket.
If you find yourself putting into the basket, stop.
The basket would cost €1, and Dutch GDP in I$ would equal Dutch GDP in euros — €60 becomes I$60.
PPP conversion only moves the number when prices actually differ between the countries.
Inflation is just a growth rate. The two approximation rules on the slide next to it look like a maths footnote — they are the reason half the Week 3 results are one line long.
Inflation is the growth rate of a price index :
Two price indices matter in this course:
Same formula, different . Everything that separates the two indices is in the next two topics.
First, a piece of arithmetic the course uses everywhere.
Both rules hold as long as , and are not too large.
Why it works, and why it eventually fails. Multiply and expand:
The answer is plus the cross term .
At 2% and 3%, the cross term is — six hundredths of a percentage point. Invisible.
At 50% and 50% it is 0.25, which is enormous. That is the whole "not too large" condition.
MULTIPLY the levels → ADD the growth rates. DIVIDE the levels → SUBTRACT the growth rates.
One operation simpler, downstairs. Times becomes plus; over becomes minus.
Nominal GDP is . If nominal GDP grows 5% and real GDP grows 2%, what is inflation?
Nominal GDP is a PRODUCT of the price level and real GDP, so rule 1 applies:
That single line reappears in Week 3 three times over: the quantity equation in growth rates, the Fisher effect, and the relation between inflation and the nominal exchange rate.
Learn it once here.
A ratio, so rule 2: .
You have just done a Week 3 exam question with no Week 3 knowledge at all.
Divide nominal GDP by real GDP and whatever is left over must be prices. A one-line definition that has carried a full exam question at least once.
You already have two measures of the same output: one at this year's prices, one at base-year prices.
Their ratio has the quantities cancelling out. What survives is a price level.
The GDP deflator, also called the implicit price deflator.
Look at the two sums. SAME quantities top and bottom — both are , this period's output. Only the price tags differ.
So the ratio answers exactly one question: what does this year's basket cost now, against what it would have cost at base-year prices?
Taking growth rates of nominal GDP = deflator × real GDP:
growth rate of nominal GDP ≈ growth rate of real GDP + inflation
is a weighted average of the prices , where the WEIGHTS CHANGE OVER TIME.
An index of that shape is called a PAASCHE price index.
The weights change because the quantities are always the current year's. If the country stops making CDs and starts making phones, the deflator's basket follows automatically.
PAASCHE = PRESENT quantities. The deflator re-weighs itself every year.
Both start with P: Paasche, present. (The CPI's Laspeyres is the other one — see the next topic.)
Data for the Netherlands:
1986: nominal GDP 220, real GDP 220 (billion euro) 1987: nominal GDP 222, real GDP 225
Which statement is correct?
a. The data imply CPI inflation was positive. b. The data imply GDP-deflator inflation was positive. c. The data imply nothing about inflation. d. None of the above.
Two of the four options can be dismissed on principle before you compute anything.
Option a talks about the CPI, and there is no consumption basket anywhere in this table — the CPI cannot be recovered from GDP figures.
Option c claims no information. But the deflator IS nominal over real, and the table gives both. So something is computable, and c is out. That leaves b and d, which differ only in a sign.
The deflator is nominal GDP divided by real GDP:
"Real GDP grew, so the economy did well, so prices rose" — no. The two move independently.
Deflator inflation is decided purely by which of nominal and real GDP grew FASTER.
The level of either one on its own tells you nothing.
Exactly 1 (or 100 if the index is scaled that way). In the base year, nominal and real GDP are the same number — the base year is the one year where the prices used are the actual prices.
The other price index: a fixed shopping basket, priced again every year. Fixing the basket is what makes it usable — and what makes it overstate the cost of living.
The consumer price index (CPI).
Compare the two indices at the level of subscripts, and one difference explains everything that follows.
The basket is usually the consumption basket of a representative household in a base period, taken from survey data.
is a weighted average of the prices where the WEIGHTS REMAIN CONSTANT over time.
An index of that shape is called a LASPEYRES price index.
LASPEYRES = LAST year's basket, kept. PAASCHE = PRESENT quantities, updated.
CPI: fixed trolley, new prices. Deflator: new trolley, both sets of prices.
In practice the two inflation rates are usually strongly correlated with each other.
Where they come apart, it is often because of imports and exports.
The rule behind both bullets: the CPI tracks what households BUY, the deflator tracks what the country PRODUCES.
Imported coffee is bought here, not produced here. Exported machinery is produced here, not bought here.
There is a broad consensus that inflation according to the CPI tends to OVERSTATE the true change in the cost of living, for two reasons:
Substitution first. Beef doubles in price, so households buy chicken instead. The fixed basket still contains the old amount of beef, so the index charges them for beef they no longer buy.
Quality second. A phone at the same price as five years ago is a better phone. The index records "no price change" when what really happened is more for your money.
That bias is why the target is not zero: there is price stability if CPI inflation is 1-2%.
Which of the following statements is correct?
a. CPI inflation UNDERestimates the change in the cost of living because it IGNORES substitution possibilities. b. CPI inflation OVERestimates it because it ALLOWS FOR substitution possibilities. c. CPI inflation accurately estimates it because it ALLOWS FOR substitution. d. CPI inflation OVERestimates it because it IGNORES substitution possibilities.
Four options built from two binary choices — over/under, and ignores/allows-for. Only one combination is right, so decide the two halves separately.
Half one: does the CPI let the basket change? No. Fixed base-year quantities, that is the definition of a Laspeyres index. So "ignores substitution" — a or d.
Half two: does ignoring substitution push the measured rate up or down? A household that switches to chicken spends less than the index assumes. The index therefore reports MORE inflation than the household feels.
The CPI holds fixed, so it cannot record households switching away from goods whose prices rose.
It keeps charging the old quantities at the new high prices. The measured increase in the cost of the basket is therefore LARGER than the increase in the cost of actually living.
Overstates, and because it ignores substitution.
Don't reason "a fixed basket is out of date, so it must understate something".
The direction is fixed by the substitution argument, and it always goes the same way: people move AWAY from what got expensive, so a frozen basket always over-weights the expensive things.
Laspeyres overstates. Paasche, for the mirror-image reason, tends to understate.
CPI inflation rises — coffee is in the household basket.
The deflator barely moves: coffee is not produced in the Netherlands, so it is not in Dutch GDP. Only indirect effects (a Dutch café charging more for a cup) show up.
Three statistics, three different denominators. The exam has asked for the one you were not expecting, and that is the whole difficulty.
Split the population AT WORKING AGE into three groups:
1. People who have a job → the EMPLOYED () 2. People who do not have a job but would like one, and are looking → the UNEMPLOYED () 3. People who do not have a job and do not want one, or are not looking → OUT OF THE LABOUR FORCE
Group 3 is the one that catches people out. A retired 64-year-old, a full-time student, someone who gave up looking — none of them is unemployed by this definition.
Not working is not enough. You have to WANT work and be LOOKING for it.
Labour force = the employed + the unemployed .
Three statistics describe the state of the labour market. Note the denominators — they are not the same.
The unemployment rate. Denominator: the labour force.
The participation rate. Denominator: everyone of working age.
The employment rate. Denominator: everyone of working age.
Only the UNEMPLOYMENT rate is measured against the labour force. The other two are measured against the whole working-age population.
u is out of L. p and e are out of the population. So : of the whole population, the share participating, times the share of those with a job.
A country has 10 million people of working age. 6 million work, 1 million are unemployed. Find , and .
The labour force is million. The remaining 3 million are out of the labour force.
The unemployment rate can fall for a bad reason.
If unemployed people stop looking for work, they leave the labour force. falls and falls, so falls — while the number of people with jobs has not changed at all.
The employment rate does not move, because its denominator does not move. That is why the course gives you all three.
The population at working age. Job flows pin down the split of the LABOUR FORCE between and , and so give you — but is measured against a denominator those flows say nothing about.
This is Exam 2022-23 Q5 exactly, whose answer is "we do not have sufficient information". Week 3 builds the job-flow model itself.
Statement II IS true.
Check: the missing 8.2% is the taxes-less-subsidies line, which is precisely what factor cost strips out.
Answer c: Statement I is not true; statement II is true.
The 2022-23 exam asked the same table the other way round — I. labour income was 50% of GDP (not true: it is MORE, because some mixed income is labour income); II. capital income was less than 41.8% (true). Same trap, mirrored.
Compute real GDP in both years with year 1 as base year, then with year 2 as base year, and the growth rate each time.
Set up a habit now that will save you in the exam: write the price row you are using ONCE, then never look at the other one.
Base year 1 means every entry uses (10, 5). Base year 2 means every entry uses (12, 3). The quantities always come from the year being valued.
Good 1 doubles, good 2 halves. So the answer will turn on which of the two is treated as expensive — which is exactly what the base year decides.
BASE YEAR 1 — use prices (10, 5):
BASE YEAR 2 — use prices (12, 3):
, , ; , , .
The economy shrank by a fifth, or did not move at all, depending on a choice you made. Neither number is wrong — which is the problem.
Use it as a free check in the exam. If your does not match nominal GDP in year , you have mixed up a row.
The average is taken as a geometric mean. The superscript ch stands for chain-weighted; the other superscripts are base years.
Compute , , , , , , , and .
Nine answers, but only four multiplications' worth of real work. Lay it out as a grid before computing anything: two base-year price rows, two quantity years.
The last two parts look like new work and are not. is nominal GDP in year 1 — which you already computed as . And is that number grown once by .
So: four products, two growth rates, one average, one multiplication.
BASE YEAR 1 — prices (10, 12):
BASE YEAR 2 — prices (15, 4):
CHAIN:
LEVELS, base year 1. Anchor at nominal GDP in year 1:
, , , , , , , , .
Nine marks, and nothing in it is harder than multiplying two numbers. This is the section to bank.
Check those two before moving on — they cost nothing and they catch a swapped price row.
Walking backward: .
Different levels from the base-1 chain (140 and 147), same 5% growth between them. That is the whole point of chain-weighting.
Step 2 in symbols: the quantity of good i in the one-dollar basket is that good's U.S. output divided by U.S. nominal GDP. The basket then has the same composition as U.S. GDP.
Build the one-dollar basket with the same composition as U.S. GDP. Then compute , , U.S. GDP in I$, the price of the basket in euros, and Dutch GDP in I$.
The order is fixed and every step feeds the next, so never skip ahead.
U.S. GDP first — you need it as the denominator for the basket. Dutch GDP you will need at the very end, so compute it now while you are already multiplying.
Then: basket quantities, basket price in euros, divide. Five answers, one chain.
THE TWO GDPs. In dollars and in euros respectively:
THE BASKET. Each good's share of U.S. output, scaled to one dollar:
Check at U.S. prices: dollar. Correct.
U.S. GDP IN I$. By definition I$1 buys one basket, and U.S. GDP is 3600 baskets, so it is I$3600.
THE BASKET IN EUROS.
DUTCH GDP IN I$. Divide the euro GDP by the euro price of one basket:
, , U.S. GDP = I$3600, €3/8, Dutch GDP = I$160.
Note the size of the result: €60 of Dutch output is worth I$160, because the basket is CHEAPER in the Netherlands than in the U.S. Fewer euros buy the same stuff.
Rule 1. The percentage change of a PRODUCT is approximately the sum of the percentage changes.
Rule 2. The percentage change of a RATIO is approximately the percentage change of the numerator minus that of the denominator.
That is: growth of nominal GDP ≈ inflation + growth of real GDP.
.
So the price level FELL.
The growth-rate shortcut gets there faster: nominal GDP grew about , real GDP grew , and
Real GDP rose faster than nominal GDP, so their ratio fell. Deflator inflation was NEGATIVE.
Answer d. Statement b has the right index and the wrong sign — the data do imply something about deflator inflation, namely that it was negative.
The official solution puts it exactly that way: as real GDP increased at a faster rate than nominal GDP, nominal divided by real has decreased.
Answer d.
Options b and c both claim the CPI allows for substitution, which contradicts the fixed basket. Option a has the direction of the bias backwards.
, , . Check the link: .