Notes on Nominal and Real GDP
Nominal GDP – measures output using current prices.
Real GDP – measures output using constant (base year) prices
Example – Suppose that the economy of Stapleville produces four goods (bread, beer,
wine and cheese) in two different years (Year 1 and Year 2).
Beer and wine are
substitutes, while the other pairs of goods are complements.
The quantities and prices for
both years are shown in the tables below:
YEAR 1
YEAR 2
Q
1
P
1
Q
1
x P
1
Q
2
P
2
Q
2
x P
2
bread
100
4
400
bread
200
5
1000
beer
200
3
600
beer
400
2
800
wine
300
2
600
wine
200
10
2000
cheese
400
1
400
cheese
600
2
1200
2000
5000
Σ(Q
1
x P
1
) = Nominal GDP
1
Σ(Q
2
x P
2
) = Nominal GDP
2
In calculating GDP, we cannot just add up the quantities of output since they are
measured in different units.
Bread may be measured in loaves, beer in gallons, wine in
bottles, and cheese in pounds.
To have a common denominator, we must have
everything measured in the same units.
This is done by multiplying the quantities times
the prices, so that we are measuring the market value of each good.
When all of the units
are measured in dollars, we can meaningfully add them up.
Here, nominal GDP for year 1 is $2000, and nominal GDP for year 2 is $5000.
To
calculate the percent change, we can use the following formula.
For any variable X, the percent change in X is equal to
%ΔX = (X
2
– X
1
)
x 100
X
1
So the percent change in nominal GDP is
[ (5000 – 2000) / 2000 ] x 100 = 150% increase.
If nominal GDP increased by 150%, does that mean that output increased by 150%?
NO!
Some of the increase in nominal GDP was due to an increase in output, but some of
it was due to an increase in prices.
In order to examine output changes, we need a way of
keeping prices constant.
This is the role of Real GDP, which measures output using
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Notes on Nominal and Real GDP
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constant or base year prices.
Here, we will assume that year 1 is the base year.
Then real
GDP will measure output using year 1 prices.
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 Spring '05
 Christianson
 Inflation, gross domestic product, BEA, GDP deflator

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