Nominal GDP
Nominal Gross Domestic Product (GDP) is a macroeconomic measure of the value of all finished goods and services produced within a country in a specific time period, typically a year. It is called “nominal” because it does not adjust for inflation or deflation, meaning it measures the output of an economy at current market prices.
For instance, if a country produced $10 million worth of goods and services last year and produces $10.5 million this year, the nominal GDP has increased. However, this increase could be due to higher production volume, higher prices, or a combination of the two.
Contrast this with Real GDP, which adjusts for changes in price level (inflation or deflation) to give a more accurate picture of an economy’s growth. Real GDP measures the value of output in an economy using constant prices, which allows for a more apples-to-apples comparison of economic output from year to year.
Nominal GDP is generally easier to compute than Real GDP, as it doesn’t require adjustment for inflation. However, when comparing GDP over time, economists often prefer Real GDP as it allows them to discern whether the growth was due to an actual increase in output as opposed to price changes.
Example of Nominal GDP
Suppose that a very small economy produces only one type of good. In Year 1, this economy produces 100 units of this good, and each unit is sold at a price of $10. Therefore, the nominal GDP of this economy in Year 1 is 100 units * $10/unit = $1,000.
Now, let’s move to Year 2. Suppose that the economy’s output increases to 110 units, but due to inflation, the price per unit rises to $11. Therefore, the nominal GDP in Year 2 is 110 units * $11/unit = $1,210.
From these numbers, it might seem like the economy’s output has increased significantly from Year 1 to Year 2. After all, the nominal GDP has increased by $210. However, this increase in nominal GDP doesn’t tell us how much of this growth is due to an increase in production and how much is due to rising prices.
This is why economists often use real GDP (which adjusts for inflation) when they want to compare economic output across different years. In this case, if we calculate real GDP using Year 1 as the base year (meaning we use Year 1 prices), we find that the real GDP in Year 2 is 110 units * $10/unit = $1,100.
This tells us that, after adjusting for inflation, the “real” growth in this economy from Year 1 to Year 2 is $100, not $210. This gives us a more accurate picture of the economy’s growth in terms of actual production, not just rising prices.
