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Wize University Macroeconomics Textbook > Measuring a Nation's Income

Nominal GDP, Real GDP and Deflator

Positive and Normative EconomicsPrevious Section
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Nominal GDP, Real GDP and GDP Deflator

In this section we will see the difference between nominal GDP and real GDP.

Nominal GDP

  • The nominal GDP is also called the current dollar GDP and it measures the value of all market goods and services produced in a given year using the price level from the current year.

Nominal GDP = Current Price x Current Quantity \boxed{\text{Nominal GDP = Current Price x Current Quantity }}

Example: Suppose that in 2005 the price of books was $50 and 10 were produced, while the price of shoes were $60 and 15 were produced. In 2006 the price of books increased to $55 and production was 9 units, while the price of shoes was $65 and 14 units were produced. 2005 is the base year.

PBooks PShoes QBooks QShoes

2005
$50
$60
10
15

2006
$55
$65
9
14


2005 Nominal GDP =
50(10) + 60(15) = $1400

2006 Nominal GDP =
55(10) + 65(14) = $1405


Real GDP

  • The real GDP is also called the constant dollar GDP or inflation-corrected GDP and it measures the value of all market goods and services produced in a given year using the price level from a base year.

Real GDP = Base Year Price x Current Quantity\boxed{\text{Real GDP = Base Year Price x Current Quantity}}

2005 Real GDP =
50(10) + 60(15) = $1400

2006 Real GDP =
50(9) + 60(14) = $1290


GDP Deflator=  Nominal GDP Real GDP⋅100\boxed{\text{GDP\ Deflator} =\ \frac{\ Nominal\ GDP}{\ Real\ GDP} \cdot100}

2005 GDP Deflator =
1400/1400 * 100 = 100


2006 GDP Deflator =
1405/1290 * 100 = 108.91

Inflation Rate= New Deflator − Old Deflator Old Deflator⋅100\boxed{\text{Inflation\ Rate} =\ \frac{ New\ Deflator\ -\ Old\ Deflator}{\ Old\ Deflator} \cdot100}

2006 Inflation Rate (from 2005 to 2006) =
(108.91 - 100)/100 * 100 = 8.91%



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Example: Nominal GDP, Real GDP and Deflator


From 2017 to 2018 the price level increased and the nominal GDP decreased on Wize Island. This means the real GDP over the same period __________

A) definitely increased
B) definitely decreased
C) may have increased or decreased
D) first increased and then decreased


B.
The nominal GDP = Current price x. Current quantity

If current price increased and nominal GDP decreased it means current quantity must have decreased by a lot.
This means real GDP must have also decreased because:

Real GDP = Base year price. x. Current year quantity.

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Example: Deflator Calculation

If nominal GDP grows by 8% and the GDP deflator increases from 112 to 119, then real GDP:
a) decreases by 4%
b) increases by 1.65%
c) decreases by 1.65%
d) increases by 4%
e) stays the same


B.
If nominal GDP is given as a percentage change then we need Deflator also as a percentage change.
Percentage change in deflator = (119 - 112) / 112 * 100 = 6.25%
When it's a percentage change you have to add 100 to all the numbers in the deflator formula:
Deflator = Nominal GDP / Real GDP * 100

106.25 = 108/Real GDP * 100

1.0625 = 108 / Real GDP

Real GDP = 108 / 1.0625 = 101.65

If every number started at 100% and now the real GDP is 101.65 that means it increased by 1.65%

Practice: Nominal GDP, Real GDP and Deflator

In 2014, Econland made 40 apples with a price of $4 each and 50 bananas with a price of $3 each. In 2015, it produced 42 apples with a price of $8 each and 60 bananas with a price of $6 each. The 2015 GDP measured in 2014 dollars was:

Practice: Real and Nominal GDP

Which of the following is (are) CORRECT?