Question

What is one potential problem that may result from calculating real GDP using constant prices of products in a base year?

• A. When prices do not change over time, the real GDP will not change either
• B. When prices decrease and output decreases over time, real GDP will decrease as well
• C. When the prices of some goods fall over time, calculating their value in constant prices makes these goods seem like a larger share of GDP than they really are
• D. When prices of all goods rise over time, calculating their value in constant prices can understate how much real output increased between years

Answer 1

The correct option is C

When the prices of some goods fall over time, calculating their value in constant prices makes these goods seem like a larger share of GDP than they really are

When goods like desktop computers and cell phones get cheaper due to decreasing costs, they should make up a smaller proportion of total GDP than when they cost much more in the past. Therefore, calculating GDP using prices from past years can overstate the actual amount of output when certain goods tend to get cheaper over time.