Questions

The answer is (B) Prices doubled between year 1 and year 2.

Here's why:

• We are given that nominal GDP (which reflects current market prices) in year 1 was $1,000 and in year 2 it was$2,000. This signifies a doubling of the nominal GDP.
• We are also told that year 1 is the base year and that real GDP in year 2 was $1,000 (which is the same as year 1's nominal GDP). Real GDP reflects the value of goods and services produced adjusted for inflation.

Since real GDP remained constant (at $1,000) between year 1 and year 2, the increase in nominal GDP must be due to a rise in prices.

Let's calculate the GDP deflator (a measure of the price level) to confirm this:

• GDP deflator (year 2) = Nominal GDP (year 2) / Real GDP (year 2)
• GDP deflator (year 2) = $2,000 /$1,000
• GDP deflator (year 2) = 2

Interpretation:

• A GDP deflator of 1 in the base year (year 1) indicates the baseline price level.
• In year 2, the GDP deflator is 2. This means that prices in year 2 are double the prices in the base year (year 1).

Therefore, prices increased by 100% (doubled) between year 1 and year 2.