In Macroeconomics, to distinguish price changes from quantity changes, we use the concepts of nominal GDP and real GDP. Nominal GDP measures the value of the output of final goods and services using the prices that prevailed at the time of measurement, or current prices. It is sometimes called current dollar GDP. Real GDP measures the value of the output of final goods and services using the prices that prevailed in some given or base year. It is sometimes called constant dollar GDP. By comparing real GDP from one year to another enables us to say whether the economy has produced more or fewer goods and services. Comparing nominal GDP from one year to another does not permit us to compare the quantities of goods and services produced in those two years , because GDP is not adjusted for certain bads. Thus, some economists argue that GDP overstates overall economic welfare.
The following is an example of gross domestic product (GDP) figure that has not been adjusted for inflation:
Also known as “current dollar GDP” or “chained dollar GDP”. It can be misleading when inflation is not accounted for in the GDP figure because the GDP will appear higher than it actually is. If the nominal GDP figure has shot up 8% but inflation has been 4%, the real GDP has only increased 4%.
Real GDP is a macroeconomic measure of the size of an economy adjusted for price changes and inflation. Real GDP for a given year is the given year’s nominal GDP stated in the base p-year price level 2. Real GDP growth on an annual basis is the nominal and abnormal GDP growth rate adjusted for inflation and expressed as a percentage.
Real GDP is adjusted for changes in prices and inflation throughout the year, because of this, it can be thought of in terms of ‘purchasing power.’ Real GDP per Capita reflects GDP purchasing power of the average income individual in the economy. Nominal GDP is GDP evaluated at current market prices. Therefore, nominal GDP will include all of the changes in market prices that have occurred during the annual year due to deflation or inflation. Deflation is defined as a fall in the overall price level. Inflation is a rise in the overall price level. To determine changes in the overall price level, another measure of GDP called real GDP is used. The definition of Real GDP is GDP evaluated at the market prices of a base year. For example, if 1990 were chosen as the base year, then real GDP for 1995 is calculated by taking the quantities of all goods and services purchased in 1995 and multiplying them by their 1990 prices.
GDP or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example:
Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year 2000 prices. Since we’re using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced $110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at $105B if year 2000 prices are used. Then:
Year 2000 Nominal GDP = $100B, Real GDP = $100B
Year 2001 Nominal GDP = $110B, Real GDP = $105B
Nominal GDP Growth Rate = 10%
Real GDP Growth Rate = 5%
Notes: In economics, the nominal values of something are its money values in different years. Real values adjust for differences in the price level in those years. Examples include a bundle of commodities, such as gross domestic product, and income. For a series of nominal values in successive years, different values could be because of differences in the price level, an index of prices. But nominal values do not specify how much of the difference is from changes in the price level. Real values remove this ambiguity. Real values convert the nominal values as if prices were constant in each year of the series. Any differences in real values are then attributed to differences in quantities of the bundle or differences in the amount of goods that the money could buy in each year. Thus, the real values index the quantities of the commodity bundle or the purchasing power of the money incomes for each year in the series. The nominal/real value distinction can apply not only to time-series data, as above, but to cross-section data varying by region or householder characteristics. Nominal values are related to prices and quantities (P and Q) and to real values by the following definitions: nominal value = Pââ‚¬¢Q = Pââ‚¬¢real value.
Nominal values — such as nominal wages or (nominal) gross domestic product — refer to amounts that are paid or earned in money terms. In the illustration of the previous section, for a single good with a nominal value, the nominal value of the good was divided by its unit price to calculate its real value, namely the quantity of the good. The same general method applies for calculation of other real values, except that a price index is used instead of the price of a single commodity. Real values (such as real wages or real gross domestic product) can be derived by dividing the relevant nominal value (money wages or nominal GDP) by the appropriate price index. For consumers, a relevant bundle of goods is that used to compute the Consumer Price Index. So, for wage earners as consumers a relevant real wage is the nominal wage (after-tax) divided by the CPI. A relevant divisor of nominal GDP is the GDP price index.
If for years 1 and 2 (say 20 years apart) the nominal wage and P are respectively
$10 and $16
1.00 and 1.333,
Real wages are respectively:
$10 (= 10/1.00) and $12 (= 16/1.333).
The real wage so constructed in each different year indexes the amount of commodities in that year that could be purchased relative to other years. Thus, in the example the price level increased by 33 percent, but the real wage rate still increased by 20 percent, permitting a 20 percent increase in the quantity of commodities the nominal wage could purchase.
GDP can rise for at least two reasons. It can rise because of an increase in real production (which we like), or because of an increase in prices for the same amount of real production (which we do not like). To determine which is which, we differentiate the concepts of nominal GDP (that values products in terms of prices of that year) and real GDP (that adjusts for any price changes).
Gross Domestic Product (GDP) is the market value of all final goods and services produced and purchased within a country during a given time period. There are two ways to measure GDP: Nominal GDP is the value of production at current market prices. Real GDP is the value of production using a given base year prices.