7.5 Nominal GDP Vs. Real GDP

What is nominal GDP?

The dollar value of final goods and services measured at current-year prices — includes inflation.

What is real GDP?

The dollar value of final goods and services adjusted for inflation, measured in base-year prices.

Why can’t we compare nominal GDP across years directly?

Because price levels change due to inflation or deflation — nominal GDP may rise even if output doesn’t.

What does real GDP allow us to measure?

True growth in output over time, without the distortion of changing prices.

If pizza costs $10 in year 1 and $25 in year 3, what does that mean for GDP?

Nominal GDP rises due to price increase, not necessarily more output — we need real GDP to compare.

How do we calculate real GDP using a price index?

Real GDP = Nominal GDP ÷ Price Index (in hundredths)
Example: $200 nominal GDP ÷ 2.50 = $80 real GDP

What is the base year in a price index?

The year where the index = 100 — used as a reference for comparing other years.

What is a price index?

A measure of the average price level of a market basket of goods compared to a base year.

How is the price index calculated?

Price Index = (Price of basket in given year ÷ Price in base year) × 100

What does a price index of 250 mean?

Prices are 150% higher than in the base year (250 − 100 = 150% increase).

What does it mean to deflate GDP?

Adjusting nominal GDP downward to remove inflation effects — gives real GDP

What does it mean to inflate GDP?

Adjusting nominal GDP upward when comparing to a year with lower prices — also gives real GDP.

What’s the formula to find real GDP from nominal GDP and price index?

Real GDP = Nominal GDP ÷ Price Index (in hundredths)

What’s the formula to find price index from nominal and real GDP?

Price Index = Nominal GDP ÷ Real GDP

What is the U.S. price index called?

Chain-type annual-weights price index — adjusts for changing spending patterns.

Why is real GDP higher than nominal GDP before the base year?

Because prices were lower — nominal GDP understates real output.

Why is real GDP lower than nominal GDP after the base year?

Because prices rose — nominal GDP overstates real output.

What does adjusting GDP allow us to do?

Compare output across years using constant purchasing power.

What is nominal GDP?

The dollar value of final goods and services at current prices when they were produced.

What is real GDP?

Nominal GDP adjusted for inflation, using base-year prices to reflect actual output growth.

Why do we adjust nominal GDP to get real GDP?

To remove the effects of inflation and compare economic growth across years accurately.

What is the formula for real GDP using a deflator?

Real GDP = Nominal GDP ÷ Deflator

How is the deflator calculated?

Deflator = Current price level ÷ Base year price level

Example: If nominal GDP is $330B and inflation is 10%, what’s real GDP?

$330B ÷ 1.1 = $300B — no real growth, just price increase.

In Year 1, 10 pizzas at $10 each — what’s nominal and real GDP?

• Nominal GDP = $100

• Real GDP = $100 (no inflation, deflator = 1

In Year 2, same 10 pizzas at $12 — what’s nominal and real GDP?

• Nominal GDP = $120

• Deflator = 12 ÷ 10 = 1.2

• Real GDP = $120 ÷ 1.2 = $100 → no real growth

In Year 3, 12 pizzas at $15 — what’s nominal and real GDP?

• Nominal GDP = $180

• Deflator = 15 ÷ 10 = 1.5

• Real GDP = $180 ÷ 1.5 = $120 → 20% real growth

What is a price index?

A measure of the average price level of a market basket compared to a base year.

How is the price index calculated?

Price Index = (Market basket price in given year ÷ Market basket price in base year) × 100

What does a price index of 120 mean?

Prices are 20% higher than in the base year.

How does the price index relate to the deflator?

Deflator = Price Index ÷ 100

What does GDP measure?

The monetary value of production — measured nominally, then adjusted to real GDP.

What does real GDP reflect?

Actual output growth, excluding price changes.

Why use base-year prices in real GDP?

To compare output across years using constant purchasing power.