Lesson summary: Real vs. nominal GDP
|nominal GDP||the market value of the final production of goods and services within a country in a given period using that year’s prices (also called “current prices”)|
|real GDP||nominal GDP adjusted for changes in the price level, using prices from a base year (constant prices) instead of “current prices” used in nominal GDP; real GDP adjusts the level of output for any price changes that may have occurred over time|
|GDP deflator||a price index used to adjust nominal GDP to find real GDP; the GDP deflator measures the average prices of all finished goods and services produced within a nation’s borders over time.|
|base year||the year used for comparison in the determination of price changes using the GDP deflator price index; the deflator in a base year is always equal to .|
|current prices||the prices at which goods are sold in a nation in a particular year; current prices are used when calculating nominal GDP.|
|constant prices||the prices from a base year that are used to calculate real GDP in other years; this allows for a more accurate measure of how a country’s actual output changes over time, because using constant prices cancels out any changes in the price level between years.|
Definitions of nominal v. real GDP
Real GDP weighs output using prices from a base year
The GDP deflator and real GDP
- An increase in GDP does not necessarily mean a nation has produced more output; it must be specified whether the GDP in question is nominal or real. An increase in nominal GDP may just mean prices have increased, while an increase in real GDP definitely means output increased.
- The GDP deflator is a price index, which means it tracks the average prices of goods and services produced across all sectors of a nation's economy over time. With this index, changes in the average price level (inflation or deflation) can be calculated between years. However, this is not the most commonly used price index for tracking inflation and deflation. The consumer price index (CPI) is the most commonly used price index, which you'll learn more about later in this course.
- Why could calculating GDP each year using current prices overstate or understate changes in actual output year to year?
- Why do increases in real GDP indicate an improvement in living standards, whereas increases in nominal GDP might not?
- The table below shows the output and the prices of Switzerland in 2017 and in 2018.
|Goods produced||2017 price||2017 quantity||2018 price||2018 quantity|