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if nominal gdp increases from year 1 to year 2 then we must have produced more goods and services in year 2 than we did in year 1.

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Lesson summary: Real vs. nominal GDP (article)

In this lesson summary review and remind yourself of the key terms and calculations used in calculating real and nominal GDP. Topics include the distinction between real and nominal GDP and how to calculate and use the GDP deflator.

Real vs. nominal GDP

Lesson summary: Real vs. nominal GDP

In this lesson summary review and remind yourself of the key terms and calculations used in calculating real and nominal GDP. Topics include the distinction between real and nominal GDP and how to calculate and use the GDP deflator.

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Lesson Overview

Even GDP needs to keep it real. When we calculate GDP using today’s prices, we are creating a measure called nominal GDP. However, prices can change even if output doesn’t change. Because of that, our measure of output might get distorted by something like inflation.

We account for this using real GDP, which is a measure of GDP that has been adjusted for the price level. In this way, real GDP is a truer measure of output in an economy. There are two approaches to adjusting nominal GDP to get real GDP: 1) using the same prices every year or 2) using the GDP deflator.

Key Terms

Term Definition

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 timeGDP 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

=100 =100 equals, 100 .

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.

Key takeaways

Definitions of nominal v. real GDP

Nominal GDP is a measure of how much is spent on output. For example, in Canada during 2015,

\text{CAN }\$1{,}994.9\text{ billion} CAN$1,994.9 billion

start text, C, A, N, space, end text, dollar sign, 1, comma, 994, point, 9, start text, space, b, i, l, l, i, o, n, end text

was spent on the goods and services produced in Canada. Nominal GDP measures aggregate output (meaning the value of all of the final goods and services produced) using current prices. In other words, these figures reflect the amount spent on Canada’s output in the country’s prices in 2015.

Real GDP weighs output using prices from a base year

Real GDP is a measure of how much is actually produced. Real GDP measures aggregate output using constant prices, thus removing the effect of changes in the overall price level. For example, in 2015 the value of Canada’s output expressed in constant 2010 prices was

\text{CAN }\$1{,}857\text{ bilion} CAN$1,857 bilion

start text, C, A, N, space, end text, dollar sign, 1, comma, 857, start text, space, b, i, l, i, o, n, end text

.

Here’s another way to think about Real GDP: if we add up all of the output that was produced in Canada during 2015 by using the prices that these goods sold for in 2010, the value of GDP in Canada is

\$1{,}857\text{ billion}$1,857 billion

dollar sign, 1, comma, 857, start text, space, b, i, l, l, i, o, n, end text

. But if we add up all of the output that was produced in Canada during 2015, using the prices that they sold for in 2015, the value of GDP in Canada is

\$1{,}995\text{ billion}$1,995 billion

dollar sign, 1, comma, 995, start text, space, b, i, l, l, i, o, n, end text

. This means prices must have increased between 2010 and 2015.

However, there is a slight problem with the method above. Calculating real GDP by weighting final goods and services by their prices in a base year can lead to an overstatement of real GDP growth because the prices of some goods decrease over time. Therefore, this method overstates growth in real GDP because it makes it seem like goods make up a bigger share of spending than they really do.

[Can you explain that further?]

The GDP deflator and real GDP

Another method of calculating real GDP involves converting nominal GDP to real GDP by using the GDP deflator, which tracks price changes of a nation’s output over time. Canada’s GDP deflator for its base year of 2010 was

100 100 100

since this is the year against which prices are compared. By 2015 the deflator had increased to

107.4 107.4 107, point, 4

, indicating that the average prices of Canada’s output had increased by

7.4\% 7.4%

7, point, 4, percent

.

By expressing 2015’s output in 2015 prices, therefore, Canada’s output would appear to have increased by

7.4% 7.4 7, point, 4

more than it actually did. Canada’s nominal GDP, which has been “inflated” by higher prices, can be “deflated” by dividing the country’s nominal GDP of

Nominal Gross Domestic Product

Nominal gross domestic product measures the value of all finished goods and services produced by a country at their current market prices.

ECONOMICS MACROECONOMICS

Nominal Gross Domestic Product

By THE INVESTOPEDIA TEAM Updated January 30, 2022

Reviewed by THOMAS BROCK

Fact checked by YARILET PEREZ

What Is Nominal Gross Domestic Product?

Nominal gross domestic product is gross domestic product (GDP) evaluated at current market prices. GDP is the monetary value of all the goods and services produced in a country. Nominal differs from real GDP in that it includes changes in prices due to inflation, which reflects the rate of price increases in an economy.

KEY TAKEAWAYS

Nominal GDP is an assessment of economic production in an economy but includes the current prices of goods and services in its calculation.

GDP is typically measured as the monetary value of goods and services produced.

Since nominal GDP doesn't remove the pace of rising prices when comparing one period to another, it can inflate the growth figure.

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Understanding Nominal Gross Domestic Product

Nominal GDP is an assessment of economic production in an economy that includes current prices in its calculation. In other words, it doesn't strip out inflation or the pace of rising prices, which can inflate the growth figure. All goods and services counted in nominal GDP are valued at the prices that are actually sold for in that year.

Effects of Inflation on Nominal GDP

Because it is measured in current prices, growing nominal GDP from year to year might reflect a rise in prices as opposed to growth in the amount of goods and services produced. If all prices rise more or less together, known as inflation, then this will make nominal GDP appear greater. Inflation is a negative force for economic participants because it diminishes the purchasing power of income and savings, both for consumers and investors.

Inflation is most commonly measured using the Consumer Price Index (CPI) or the Producer Price Index (PPI). The CPI measures price changes from the buyer's perspective or how they impact the consumer.1 The PPI, on the other hand, measures the average change of selling prices that are paid to producers in the economy.2

When the overall price level of the economy rises, consumers have to spend more to purchase the same amount of goods. If an individual’s income rises by 10% in a given period but inflation rises 10% as well, then the individual’s real income (or purchasing power) is unchanged. The term real in real income merely reflects the income after inflation has been subtracted from the figure.

Nominal GDP vs. Real GDP

Likewise, if we were comparing the GDP growth between two periods, the nominal GDP growth might overstate the growth if inflation is present. Economists use the prices of goods from a base year to act as a reference point when comparing GDP from one year to another. The difference in prices from the base year to the current year is called the GDP price deflator.

For example, if prices rose by 1% since the base year, the GDP deflator would be 1.01. Overall, real GDP is a better measure any time the comparison is over multiple years.

Real GDP starts with nominal GDP but factors in any change in prices from one period to the other. Real GDP is calculated by taking the total output for GDP and dividing it by the GDP deflator.

For example, let's say the current year's nominal GDP output was $2,000,000, while the GDP deflator showed a 1% increase in prices since the base year. Real GDP would be calculated as$2,000,000/1.01 or $1,980,198 for the year. One of the limitations of using nominal GDP is when an economy is mired in recession or a period of negative GDP growth. Negative nominal GDP growth could be due to a decrease in prices, called deflation. If prices declined at a greater rate than production growth, nominal GDP might reflect an overall negative growth rate in the economy. A negative nominal GDP would be signaling a recession when, in reality, production growth was positive. Compete Risk Free with$100,000 in Virtual Cash

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A period during which real GDP declines is called a recession.

True False

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A farmer grows wheat and sells it to the miller for $87. The miller turns the wheat into flour and sells it to the baker for$125. The baker turns the flour into bread and sells it to consumers for $194. What is the value added by the baker? Enter a whole number with no other characters. Click card to see definition 👆 69 Click again to see term 👆 1/68 Created by erinrussell1999 Terms in this set (68) A period during which real GDP declines is called a recession. True False true A farmer grows wheat and sells it to the miller for$87. The miller turns the wheat into flour and sells it to the baker for $125. The baker turns the flour into bread and sells it to consumers for$194. What is the value added by the baker? Enter a whole number with no other characters.

69

Capital goods are goods that will be used in the future to produce more goods and services.

True False true

A firm produces 100 units of some good in the year 2017 but only manages to sell 90 of the units. When we calculate GDP for the year 2017 we will count the value of the 90 units sold and ignore the value of the 10 units not sold.

True False false

Net export spending will have a negative value when the country exports more goods than it imports from other countries.

True False false

When a business such as CarMax sells a used car to an individual for $9,000 then no part of this transaction counts in GDP because the car is used. True False false When a private individual sells a used car to another individual, this does not count in GDP. True False true Nominal GDP increases from year 1 to year 2. Therefore: - We produced more goods and services in year 1. - It is not possible to determine in which year we produced a greater quantity of goods and services. - We produced more goods and services in year 2. It is not possible to determine in which year we produced a greater quantity of goods and services. In 1988 the value of RGDP was$8,474.492 billion, the population was 244.499 million, and the number of people employed was 115,060 measured in thousands. What was the value of real GDP per capita? Round to the nearest whole number. Do not enter a dollar sign.

34661

In a given year, nominal GDP is $442 and real GDP is$381. Find the GDP deflator. Enter a number rounded to two decimal places.

116.01

When your parents pay your tuition bill to UCF this counts as a consumption expenditure.

True False true

A farmer grows wheat and sells it to the miller for $47. The miller turns the wheat into flour and sells it to the baker for$79. The baker turns the flour into bread and sells it to consumers for $132. As a result of these transactions, GDP will increase by how much? Enter a whole number with no other characters. 132 When the government pays social security to elderly people, this counts as: a transfer payment. investment spending. government purchases. consumption spending. transfer payment We can use the GDP deflator to calculate the inflation rate in the economy. True False true The four categories of expenditure (spending) in the economy are wages, rent, interest, and profit. True False false Company A produces paper and sells it to Company B for a total of$159. Company B uses the paper to make books and then sells the books to consumers for a total of $321. What is the value of GDP in this simple economy? Enter a whole number with no other characters. 321 When Toyota produces cars in the United States this does count in GDP even though Toyota is not an American company. True False true The government pays social security benefits to your grandfather every month. When your grandfather spends his entire social security check on groceries at the supermarket this counts as: investment spending. consumption spending. government spending. a transfer payment. consumption The largest component of GDP is investment spending. True False false If the price of a banana is twice the price of an apple, then the sale of a banana contributes twice as much to GDP as the sale of an apple. True False true In the economy, income earned when producing new final goods and services must equal expenditure on the new final goods and services. True False true GDP increased from$16.35 trillion to \$17.1 trillion. What was the growth rate of GDP? Enter a number rounded to two decimal places. Do not enter any other characters.

4.59

There are 82 unemployed people and 1121 employed people. What is the unemployment rate? Enter a number (measured in percentage terms) rounded to two decimal places. Do not enter a % sign.

6.82

According to the Bureau of Labor Statistics, you are considered to be unemployed if you have no job.

True False false

An increase in the minimum wage is likely to _____ the quantity of labor demanded and at the same time is likely to _____ the quantity of labor supplied.

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James 11 month ago

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