by Vinayak Maheswaran

Created on: July 23, 2011   Last Updated: July 25, 2011

Real and Nominal GDP

We mentioned that GDP is an attempt to measure the value of resources created by an economy in a given point in time. How can we aggregate together different goods? that's what dollar prices are for. We can aggregate computers and bread just by summing their total value (price times quantities). This measure is called nominal GDP or GDP at current prices. The problem with that measure is that the general price level is going up, so we might observe our measure of GDP going up even if the stuff produced is not. A better measure is therefore real GDP.

 Real GDP computed using the base year method is just quantities, multiplied by the price in a fixed year. The ratio between nominal and real GDP is called the GDP deflator and it is a measure of the general price level. Often GDP deflator growth is used as a broad measure of inflation, that is of the change of the general price level. In the example below we compute nominal GDP, real GDP and GDP deflator for an economy that produces only bread and computers.

                   P(Br)       Q(Br)      P(Comp)        Q(Comp)

1990               10        100         100                   10

1995               20        110          80                    20

2000               30        120          50                    40

Nom GDP                                          Real GDP(Base1990)                           

• 1
• 2
• 3
• Next Page >>