4.5 Nominal and Real GDP

The distinction between nominal and real measurements refers to whether inflation distorts a given statistic. Looking at economic statistics without considering inflation is like looking through a pair of binoculars and trying to guess how close something is: unless you know how strong the lenses are, you cannot guess the distance very accurately. Similarly, if you do not know the inflation rate, it isn’t easy to figure out if a rise in GDP is due mainly to a rise in the overall level of prices or to a rise in the quantities of goods produced. The nominal value of any economic statistic means that we measure the statistic in terms of actual prices at the time. The real value refers to the same statistic after it has been adjusted for inflation. Generally, it is the real value that is more important.

Calculating Nominal GDP

As mentioned, nominal GDP is the value of the goods and services produced in the stated year.

[latex]\text{Nominal GDP}=\text{Price}\times\text{Quantity}[/latex]

Therefore, the nominal GDP is simply the sum of all individual contributions.

Let us consider an economy that only produces three goods: apples, bananas, and cherries. The economic agency of that economy reports the production and pricing data in Table 4.9.

To calculate each year’s nominal GDP, we multiply each good’s price by the corresponding quantity. Then, add up all of the individual contributions.

[latex]\begin{align*}\text{NGDP}_{18}&=(\$1.00)(200)+(\$0.50)(300)+(\$6.00)(20)=\$200+\$150+\$120=\$470\\[2ex]\text{NGDP}_{19}&=(\$1.25)(260)+(\$0.50)(350)+(\$6.50)(30)=\$325+\$175+\$195=\$695\\[2ex]\text{NGDP}_{20}&=(\$1.50)(260)+(\$0.80)(450)+(\$7.50)(30)=\$390+\$360+\$225=\$975\end{align*}[/latex]

Calculating Real GDP

For the real GDP calculation, we pick a year called the base year. This information will always be given to you.

[latex]\text{Real GDP}=\text{Base Year Price}\times\text{Current Year Quantity}[/latex]

For our example, let us call 2018 the base year. Then, we keep prices constant at base year levels. For our example, we will use $1.00 as the price of apples, $0.50 as the price of bananas, and $6.00 as the price of cherries for each year. This allows us to focus only on changes in production rather than allowing for changes in the price level. In our example, the real GDPs would be calculated as:

[latex]\begin{align*}\text{RGDP}_{18}&=(\$1.00)(200)+(\$0.50)(300)+(\$6.00)(20)=\$200+\$150+\$120=\$470\\[2ex]\text{RGDP}_{19}&=(\$1.00)(260)+(\$0.50)(350)+(\$6.00)(30)=\$260+\$175+\$180=\$615\\[2ex]\text{RGDP}_{20}&=(\$1.00)(260)+(\$0.50)(450)+(\$6.00)(30)=\$260+\$225+\$180=\$665\end{align*}[/latex]

Notice that the price for each good remains constant. Because of this, any increase in the real GDP must be caused by increased production.

You should also notice that the nominal and real GDP are identical in the base year. This is not a coincidence. In our example, 2018 was the base year. The nominal GDP for 2018 used the price level from 2018. The real GDP for 2018 used the price levels from the base year…which was 2018. Therefore, the calculation for 2018 and any base year will always be identical.