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Real GDP and nominal GDP

AP.MACRO:
MEA‑1 (EU)
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MEA‑1.I (LO)
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MEA‑1.I.1 (EK)
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MEA‑1.I.2 (EK)
Nominal GDP measures output using current prices, while real GDP measures output using constant prices. We can explore how price changes can distort GDP using a visual representation of GDP. Created by Sal Khan.

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  • leaf blue style avatar for user Mike
    Sticking with the Apples example, I'm curious about whether or not productivity is only a measure of the actual quantity of Apples produced. What if, for example, Apples in Year 2 were more delicious or more nutritious which, without changing the weight, leading to an increased aggregate demand for the apples (elevated prices)? Is quality a factor in productivity, or merely quantity? Or am I just way over-thinking what was meant to be a primer for inflation adjustment?
    (121 votes)
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    • piceratops ultimate style avatar for user Alex
      This is a very good point, I'm glad you brought this up. The GDP, real or nominal, doesn't take into account either quality of the goods that are produced or any new products that may have emerged in the market since the base year. This is a major deficiency of GDP as a measure of the standard of living in a country over time. These changes in our standard of living along with unpaid housework, volunteer work, and environmental degradation too name a few, are all called externalities. Externalities aren't reflected in the prices of goods or services exchanged between consumers and producers and thus aren't factored into GDP. A great example of the increase in quality that you're talking about is computers over the last 20 years. Although computers have become exponentially faster, more efficient, and more user-friendly, their effect on the GDP hasn't been nearly as substantial as the effect they have had on our standard of living.
      (104 votes)
  • blobby green style avatar for user Taggartus
    If I were to apply this to the real world, what year would I base a country's Real GDP off of?
    (57 votes)
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    • blobby green style avatar for user Gary Hayslip
      Presently I believe 2005 is being used as the base year for the United States. So you go to I believe the U.S. Bureau of Economic Analysis (BEA) and they have many of the charts there that are used by the Fed and different agencies for figuring out GDP.
      (37 votes)
  • blobby green style avatar for user 7speter
    So is the real GDP a measure of production or costs? Or is it a measure of both?
    (6 votes)
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    • leaf green style avatar for user SteveSargentJr
      Definition of GDP
      GDP is the total market value of all final goods and services produced within a country's border over a given time period (typically one year).

      So basically, it's a measure of production.

      Because of Inflation, prices have risen over time--as you'd know if you've ever talked with my grandfather ("In my day, Coca-Cola was a nickel!"). Therefore, if a country's nominal GDP was 20% higher in 2012 than it was in 2002, it could be the case that everything is just 20% more expensive or it could be the case that 20% more goods were produced (or something else). Thus, in order to meaningfully compare the changes in GDP over time, it's helpful to calculate "real GDP", which (like nominal GDP) is a measure of the total value of final goods produced but removes the effects of inflation from the GDP number. Is this helpful?
      (27 votes)
  • leaf green style avatar for user Chris Lam
    Whats the significance if Real GDP exceeded that of Nominal GDP?
    (9 votes)
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    • leaf green style avatar for user Sharang Sinha
      To understand why the prices are falling you will need to have a look at the formulation of Nominal and Real GDP:
      Nominal GDP = Quantity A * CurrentPrice
      Real GDP= Quantity A* BasePrice

      For the Nominal GDP to come out less than Real GDP, the Current Price of Commodity 'A' has to be less that what it was in the Base Year.

      Thus, the Economy would be going through a deflation.
      (7 votes)
  • marcimus pink style avatar for user Agnieszka
    If the GDP number is so hard to estimate, often turns out to be inaccurate and I suppose it involves a lot of bureaucracy and further government spending, wouldn't it be better not to count it at all?
    (7 votes)
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    • blobby green style avatar for user Oskar Ege
      There are plenty of benefits to having the GDP-numbers accessible. One of the most obvious reason is so that firms can make better informed decision based on forecasts of how GDP is expected to develop in the near future. This makes investments more effective in allocating funds as well as the willingness to risk funds greater since they have better knowledge of the economics.
      However, most of what GDP will tell you about the future of the economy you can find out in different ways as well. (surveys of economic confidense and so on)
      (12 votes)
  • female robot grace style avatar for user Natalie
    Doesn't inflation only take into account a basket of goods/services? If so, how is it possible to completely adjust GDP for inflation, since some goods/services won't be in that basket?
    (6 votes)
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    • spunky sam blue style avatar for user Niema Moshiri
      Realistically, it's impossible to completely adjust GDP for inflation. To do so, we'd have to take into account literally every single thing that's for sale. That's why, when they do that, they take the big and important things into account: housing/rent, food, cars, etc.
      (4 votes)
  • leaf green style avatar for user Eric Murphy
    I read that the year modern economies base off of is 5 years prior. How would that work? The prices would still change, it would just be 5 years in the past.
    (5 votes)
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    • leaf grey style avatar for user Shlomo Fingerer
      You would calculate the GDP of every year that you want, in 5 years ago curency. For example: If I want to calculate in the year 2012, I would take the GDP numbers for the last... 50 years, and convert every years figure to the price it would cost for those goods and services in 2007! (By the way, a late: Welcome to KA! You are truly one of our stars! Thank you for enhancing our community!)
      (4 votes)
  • leafers tree style avatar for user maurice fred choo
    Real GDP = Nominal GDP / GDP deflator * 1O0

    How to find GDP deflator ?? which is GDP deflator?
    (6 votes)
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  • blobby green style avatar for user Jessica Kaur
    How would I calculate the Real and Nominal GDP for two products? Instead of just one.
    (3 votes)
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    • spunky sam blue style avatar for user robartsd
      To adjust for price, we create some sort of price index which attempts to follow price changes in general by taking a weighted average of many prices. A common index used in the United States is the Consumer Price Index. Of course there are different opinions of how to weigh all the prices, so this is another area where economics relies on approximation and assumption.
      (4 votes)
  • blobby green style avatar for user averagejoel
    Is it accurate to say that this video answers the question "How much did the productivity increase from year 1 to year 2 measured in dollar?"
    (2 votes)
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Video transcript

Let's say we're studying a very small and oversimplified country that only sells apples, and we measure the GDP in year one. And we measure that GDP as $1,000. And all of that is due to apples. And we also know that the price of apples in year one was $0.50 a pound. So I'll write it as $0.50 per pound. And let's say that now year one has gone by and even year two has gone by, and we're able to measure the GDP in year two. So the GDP in year two is $1,200. And the price of apples in year two, let's just say it is $0.55 a pound. So my question to you is, GDP, the whole point of measuring GDP, is measuring the productivity of a country. I mean we are measuring in terms of dollars, but we care more about just the dollar amount. We really care is, was this country more productive? And if it was more productive, how much more productive was it? And if we just look at these GDP numbers right over here, this $1,000 versus this $1,200, it gives you the sense that-- well, at least if you just look at the numbers-- $1,200 is 20% larger than $1,000. So if you just look at those numbers right over there, it looks like the GDP grew by 20%. But is that an accurate representation of the productivity of this country? Did it actually produce 20% more goods? And a big clue is looking at this price here. Because some of this GDP actually might have increased just due to price. But that doesn't actually make the country more productive. The quantity, the extra quantity of apples that the country produces, is actually what adds to the total productivity. One way to think about it-- Let me draw a little diagram over here. On this axis, I'll do quantity. On this axis, I will do price. And P1, so if I want to figure out the GDP in year one, I would have the price of apples in year one-- that's the only good or service, just to simplify things-- times the quantity of apples in year one. And then this right over here, the area of this green rectangle, would GDP in year one. And then GDP in year two would be the price in year two. So we're going to go from $0.50 to $0.55. The price in year two times the quantity in year two-- we'll assume some growth as occurred-- times the quantity in year two. And so GDP in year two would be the area of this entire rectangle. And if we want to find the difference between GDP in year two and GDP in year one, it would be the difference in area. So it would be what I am shading in, in blue right over here. And based on the numbers that we went over right over here, the area that I'm shading in, in blue-- so the difference between GDP in year two and GDP in year one, the area I'm shading in blue-- would be this 200, the 200 increment. So this area right over here would be that 200. Now when you look at it over here, you see that that 200, some of it is due to an increase in quantity. But a lot of it is also due to an increase in price. So if we really wanted to figure out how much more productive the country got, and we still want to measure GDP in dollars, maybe we can take a measure of GDP that measures year two's GDP, but it does it in year one's prices. So if we could somehow multiply-- if we could multiply year two's quantity by year one's prices, then we would get this rectangle right over here. And then the difference between that and year one, would give us the incremental GDP in year one prices due to quantity. And that's what we care about. We care about total productivity. When we're thinking about GDP one, we say how much more productive did the country get? So let's try to do it with these numbers right over here. So we can figure out quantity two, we could figure out the quantity in year two just by dividing the GDP by the price. Just by dividing this area of the entire blue rectangle and dividing it by the price, that will give us the quantity. So if we divide 1,200 divided by $0.55-- let me get my calculator out. So if I do 1,200 divided by $0.55, this is my quantity of apples and in pounds in year two. And I'll just round it, 2,182. So this is 2,182. So the quantity in year two is 2,182 pounds. So this is equal to that. And then I could multiply this times the price. So this is this quantity. It's 2,182 pounds. And then I could multiply it times the price in year one at year one's price. So I'm going to multiply it times-- P1 is equal to $0.50 a pound, $0.50 per pound. And this will give me-- so let me just get my calculator out. I should be able to do that one in my head. But let's see 0.5. And I get 1,090. Obviously, I'll round it to 1,091. So this is equal to 1,091. And this is an interesting number. So this is-- you could view this as year two's GDP. In year-- or adjusted for-- I'll write it, adjusted for prices, or adjusted for price increases. Or you could say in year one prices. And what's useful about this is, this says, look, if prices had remained constant, this is what our GDP would have gotten to. If prices did not increase, our GDP would have gotten to this 1,091. 1,091 is this area that I drew in pink here. And so now, you could say if prices were held constant, the growth in GDP would have been $91 not $200. So this area right over here that I'm-- actually, let me do it in a color. Let me do it in orange, maybe. This area right over here, the actual growth, if prices were held constant, would have been $91. We would have gone from $1,000 of GDP to $1,091. So this right over here, that area, is $91 of-- and we could even call it real growth. It really measures the productivity. Now this gives us an interesting, I guess, set of ideas. One idea is to just measure your GDP in the current year's dollars. So this was GDP measured in year two's dollars. It was year two GDP measured in year two dollars, year two prices. So we could call that year two's nominal GDP. Nominal, in name. So it's GDP in name, in that year's prices. But this right over here, where we measured year two's GDP, in some base year's prices-- so it allows a real comparison of how much did our productivity actually increase. Our productivity actually increased by 9%. We produced 9% more apples. This, we call real GDP. Because it gives you a measure of real productivity. It tries to take out price increases. What we'll see in the future, or we might not do it in an introductory course, but in practice, it's kind of hard to really measure what the absolute-- this was a simple economy, where we only had one product. But if you have many, many, many products-- actually gazillions of products in a real economy and the prices are adjusting and the quantities are adjusting, it's not so easy to figure out how to adjust for price. But the folks running the national income accounts do try to do this. So they get a sense of how much was the actual real growth.