Question

Historically, why has real GDP increased more slowly than nominal GDP?

1) Inflation has been high, causing the value of money to decrease over time.
2) The population has been growing rapidly, leading to higher overall economic output.
3) Technological advancements have resulted in increased productivity and higher nominal GDP.
4) Government policies have focused on promoting nominal GDP growth at the expense of real GDP growth.

Answer 1

Real GDP has historically increased more slowly than nominal GDP because it adjusts for inflation, which has been high, especially in the 1970s. This adjustment extracts price increases from the GDP, allowing real GDP to measure true output change.

Step-by-step explanation:

Historically, real GDP has increased more slowly than nominal GDP predominantly because inflation has been high, which lessens the value of money over time. When we observe economic data, we notice that the rise in nominal GDP tends to be larger than the rise in real GDP due to the influence of inflation. This is particularly evident in time periods such as the 1970s when inflation was especially high.

To measure the actual change in economic output, rather than changes influenced by price alterations, we adjust nominal GDP by using a price index or deflator, which results in real GDP. This adjustment removes the effects of inflation, allowing us to understand the true increase in the quantity of goods and services produced. In essence, real GDP accounts for the change in the physical output of the economy, excluding any changes in the price level.

Over the years, as shown in historical data like figure 19.8 and figure 6.9, while the nominal GDP appears to have grown significantly, much of that growth reflects changes in price levels rather than an actual increase in production. Therefore, real GDP is a better indicator of economic growth as it reflects the actual increase in output after adjusting for inflation.