Applications of real GDP

Comparing Standard of Living from Two Different Years

Real GDP per person: is the real GDP divided by the population.

To compare the standard of living over two different years, we find the ratio. Suppose we want to compare year 2000 with year 2018. Then

Ratio $\frac{Real \; GDP \; per \; person_{2018} } {Real \; GDP \; per \; person_{2000} }$

Note: the ratio tells us how many times well off people were in 2018 than in 2000.

Comparing Standard of Living over Time

Potential GDP: The maximum level of real GDP when avoiding shortages of labor, capital, land, and any entrepreneurial abilities that could create inflation.

Potential GDP per person: the potential GDP divided by the population.

To find the standard of living over time, we can graph both the real and potential GDP per person over time.




In the graph, we notice 2 things:

1. Continuous growth of potential GDP per person: this rises at a steady pace because the quantities and productivity of the factors of production are also rising at a steady pace. Note that it does not grow at a constant pace (not a line).


2. Real GDP per person fluctuates: it moves above and below the potential GDP and creates a cycling pattern, which we call the “business cycle”.

The business cycle has 2 phases and 2 turning points:

1. Phases: Expansion and Recession
2. Turning points: Peak and Trough

Comparing Standard of Living Across Countries

There are two ways to compare the standard of living across countries:

1. Comparing Real GDP per person: convert one country’s currency to the other using the market exchange rate, and then find the ratio to see how well off one country is compared to the other.


2. Purchasing Power Parity (PPP): we value one country’s production the same term as another country.