82 Comparing Nominal and Real GDP
Learning Objectives
- Explain and demonstrate the difference between nominal and real GDP
Comparing Nominal and Real GDP
In the last section, we introduced the difference between real measurements and nominal measurements of the same economic statistic. On this page, we explore this challenging, but important, distinction in more depth.
Table 1 shows U.S. GDP at five-year intervals since 1960 in nominal dollars; that is, GDP measured using the actual market prices prevailing in each stated year. This data is also reflected in the graph shown in Figure 1.
| Table 1. U.S. Nominal GDP (1960-2010) | ||
|---|---|---|
| Year | Nominal GDP (billions of dollars) | |
| 1960 | 543.3 | |
| 1965 | 743.7 | |
| 1970 | 1,075.9 | |
| 1975 | 1,688.9 | |
| 1980 | 2,862.5 | |
| 1985 | 4,346.7 | |
| 1990 | 5,979.6 | |
| 1995 | 7,664.0 | |
| 2000 | 10,289.7 | |
| 2005 | 13,095.4 | |
| 2010 | 14,958.3 | |
| Source: www.bea.gov, National Accounts |
If an unwary analyst compared nominal GDP in 1960 to nominal GDP in 2010, it might appear that national output had risen by a factor of nearly twenty-seven over this time. This conclusion comes from the simple growth rate formula (or percentage change formula):
(Final GDP – Initial GDP) / Initial GDP = Growth of Nominal GDP
or
($14,958 – $543) / $543 = 2653%
This conclusion, though, would be highly misleading. Recall that nominal GDP is defined as the quantity of every final good or service produced multiplied by the price at which it was sold, summed up for all goods and services. In other words, nominal GDP is the value of output produced:
[latex]\text{Nominal Value of Output}=\text{Price}\times\text{Quantity of Output}[/latex]
We’ll call this the Real-to-Nominal formula.
Watch It
Watch this video to see an example of how inflation can distort our perception of GDP. In this example, we focus on a simplified economy with only one good: apples.
GDP in year one is $1000 and the GDP in year two is $1200. The price for apples in year one was $0.50 per pound, but it rose to $0.55 per pound in year two. We know that the value of apple production increased, but we want to determine the extent to which we are producing more apples (i.e. more quantity of goods and services). Since the value of apples is the price of apples times the quantity produced, we can determine the quantity of apples produced in any year by dividing the value of apples in that year (e.g. $1000 in year one) by the price of apples in that year (e.g. $0.50 in year one):
[latex]\frac{1000}{0.50}=2000\text{ lbs of apples in year one}[/latex]
We can do the same calculation for year two:
[latex]\frac{1200}{0.55}=2182\text{ lbs of apples in year two}[/latex]
The difference in the number of apples produced is 182 lbs. The growth rate (percentage increase) is
[latex]\frac{182}{2000}=.091\text{ or }9.1\%[/latex]
Now compare this with the growth in the value of apples:
[latex]\frac{1200-1000}{1000}=\frac{200}{1000}=0.20\text{ or }20\%[/l