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## Macroeconomics

### Course: Macroeconomics>Unit 2

Lesson 6: Real vs. nominal GDP

# GDP deflator

Examine the complexities of measuring prices in an economy with multiple goods and services. See how economists use an index to measure changes in prices over time, and to calculate real GDP and nominal GDP. You'll also learn about the GDP deflator, which is used to adjust nominal GDP for inflation in order to get real GDP. Created by Sal Khan.

## Want to join the conversation?

• Can you please this concept for me?
Nominal GDP: the GDP in year 2's prices
Real GDP: the GDP with inflation taken into account • so if an economists would want to find the real GDP of a country, he would divide it by the percentage of the inflation in that country in the given time? • Yes, more or less. To find real GDP, you divide the Nominal GDP by a suitable price index (usually the GDP Deflator). Dividing by any other price index (such as the Consumer Price Index) is usually not appropriate because the CPI only considers Consumption goods (and not Investment goods and government expenditures).
• If a new product comes out in one year which did not exist in the year you are using as your base year how can you figure out its price in the base year? Do you just assume that it would have the same price in the base year if it would have existed at that time? • Why divide nominal gdp by 1.10 to deflate it and get real gdp instead of multiply by 0.90? Why do the two answers differ? • We do that to counter changes in prices and get the real picture. Prices were earlier at 100 and are now at 110, they have increased by 10%. Whereas by multiplying by 0.9 you are saying that the prices in the base year are 90% of that of the current year, which thus means that you are saying that the prices have increased by
(100-90)/90 i.e by 11%.
• I love the way you frequently repeat the main statements that are important. • It's almost easier just to go with the rate of inflation and the base GDP %, find the difference and that's the Read GDP. For example, we have a 1% GDP in year 1 and a 4% GDP in year 2. Inflation is 2%. You'd find the difference between the 1st and 2nd year, which in this case is 3% rise in GDP minus the 2% inflation so REAL GDP increase between year 1 and 2 is really 1%. Or if you want to just the GDP for year 2: 4% from year 1 minus 2% inflation which gives us a REAL GDP of 2%.
(1 vote) • The main problem with your approach is that you are assuming that you know ahead of time what the inflation rate is. In reality, the GDP deflator is one way (along with other indices such as the CPI) economists attempt to measure the rate of Inflation.

The second thing to remember (though this isn't as important as my first point) is that subtracting the inflation rate from the growth rate of nominal GDP only gives a first-order approximation of the real GDP growth rate.
Here's an example of the precise way of calculating the real GDP growth rate:
Given:
Growth in nominal GDP: 6%
Inflation rate: 2.5%
Then to calculate growth rate of real GDP:

Growth rate in real GDP = [(1.06)/(1.025) -1]* 100%
which is approximately equal to 3.415%.

This difference might not seem like a lot (i.e. compared to 3.5%) but it's especially important if you try to calculate inflation over multiple time periods. In addition, when dealing with GDP, even fractions of a percent can amount to hundreds of billions of dollars.
Hope this helps!
• Hi. I have a question about the quantity of GDP. Are both the Real GDP and the Nominal GDP based on the same quantity of goods? And is the only difference between them the inflation of price? • Sorry if I am repeating already said information, but is it safe to say that real GDP is basically GDP according to a previous year, just adjusted for inflation? • What exactly can be used for a deflator? I apologize if I missed an obvious point in the video, I just being 100% sure that I've grasped a subject. • In order to calculate the gdp deflator they said you should divide the nominal gdp with the real gdp and then multiply it over 100 right?
so why do i end up with the nominal gdp of 110 after i do that? • The Deflator express how the prices in current year changed over the base year (inflation). So when you compare the Nominal GDP (at current year prices) to Real GDP (at base year prices) you basically compare the same production at different price level. In your case - The Deflator is 110% which means that in current year the price is 110% of the price in the base year. (there is an increase in price)

So if the price in year base year is "x" ; the price in the current year is 110% * x = 1.1*x

For example - You have a country that produces just one good, lets say apples.
The Nominal GDP in year A = 100 \$ & The Nominal GDP in year B = 138 \$. So there is an increase of 38\$ in the GDP; but the price of an apple in year A = 1\$ and the price in year B = 1.2\$

Which means that the total units of apples produced in year A = 100 apples (100\$/1\$)
For year B the total units of apples produced is B = 138\$/1.2\$ => B = 115 apples

If the year B nominal GDP was adjusted to inflation, so that the total units sold were calculated at year A prices (since year A is the base year), the Real GDP in year B would be = 115 (apples in year B) * 1\$ = 115\$. So the real increase in GDP is 115\$-100\$= 15\$; the rest is due to price change(inflation) which is (38\$-15\$ = 23\$) . So 23\$ increase in the GDP is due to price change and only 15\$ is due to increase production.

If you were to calculate the Deflator now (for verification) it's Nominal GDP/Real GDP - in this case you've got 138\$/115\$ = 1.2 (multiply it over 100) you get 120%. So the price in year B is 120% of the price in year A. Which means : - (Price in year A) * 120% = Prince in year B => 1\$ *120% = Price in year B
=>1.2\$ = Price in year B (which is correct).