Nominal vs. Real GDPThis is a featured page

Nominal vs. Real GDP:
  • GDP is a measure of the market or money value of all final goods and services produced by the economy in a given year. we use money or nominal values as a common denominator in order to sum that heterogeneous output into a meaningful total.
  • Since market value is measured by money, it is hard to compare the market values of GDP from year to year if the value of money itself changes in response to inflation and deflation. To solve this problem, we deflate GDP when prices rise and inflate GDP when prices fall according to a base year.
  • Nominal GDP (unadjusted for inflation): Refers to GDP based on the prices of a product in the year it was produced. Not inflated or deflated.
  • Real GDP (Adjusted for inflation): Refers to a GDP that has been adjusted for inflation or deflation to accurately show the increase or decrease in production for comparison of economic growth from year to year. Measured in relation to the price index of a given year.

GDP price index:
  • A Price Index is a measure, or ratio, of the price of a specified collection of goods and services (market basket) in a certain year as compared to the price of the same or extremely similar "market basket" in a reference year (base year/ base period).
  • Market Basket: specified collection of goods and services.
  • Price Index in a certain yr =(Price of market basket in specific yr/Price of same market basket in base yr) x 100
    • Price index= Nominal GDP / Real GDP. Multiply the base year's price to the output of each year to get the total real GDP. Multiply each year's price to its corresponding output and add them up to get total nominal GDP.

    Dividing nominal GDP by price index
    • Real GDP = nominal GDP / price index (in hundredths).

    An alternative method:
    1. Gather separate data on physical outputs and their prices.
    2. Determine the market value of the outputs in successive years if the base-year price had prevailed, this determines real GDP.
    3. Now you can identify the price index with the following equation: Price Index (in hundredths) = nominal GDP / real GDP.

        Real-World Considerations and Data
        • Government must assign “weight” to each of several categories of goods and services based on the relative proportion of each category in total output. Deduces expenditure patterns.
        • These “weights” are updated annually and the base year roll forward year by year using a moving average of expenditure patterns
        • US uses GDP price index called the chain-type annual-weights price index



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