Nominal and real GDP
Definition
Nominal GDP: a country's output measured at current prices.
Real GDP: the same output measured at constant base-year prices to remove the effect of inflation.
The core distinction
- Real GDP values output using the prices of a fixed base year, holding prices constant.
- So a rise in nominal GDP can come from higher prices, higher output, or both.
- A rise in real GDP reflects only extra output, which is genuine economic growth.
Key Idea
- Nominal GDP can rise simply because prices have risen.
- A price index, such as the GDP deflator, converts nominal GDP into real GDP.
Converting nominal to real
- As a shortcut, real growth is approximately nominal growth − the inflation rate.
- More precisely, real GDP is nominal GDP scaled by a price index with the base year set at 100.
- So a rise in prices on its own is not real growth.
Real GDP
Real GDP=Nominal GDPprice index×100 \text{Real GDP} = \dfrac{\text{Nominal GDP}}{\text{price index}} \times 100 Real GDP=price indexNominal GDP×100Example
- Last year real GDP was £500bn; this year nominal GDP is £530bn and the price index is 106 (base year = 100).
- Real GDP is still £500bn, so nominal GDP rose 6% purely because prices rose 6% and real growth is 0%.
- Had prices risen only 2% instead, real growth would have been about 6% − 2% = 4%.
Why real matters
- Nominal figures can rise even when the economy produces no more goods and services.
- Real figures reveal genuine changes in output over time.
- Real GDP uses constant prices, so performance across years is judged in real terms.
Exam technique
- Convert nominal figures to real before comparing across years.
- Subtract the inflation rate from nominal growth to estimate real growth.
Common Mistake
- Do not compare nominal GDP across years without adjusting for inflation.
- Doing so overstates the true rise in output.
Self review
- Define nominal GDP.
- Define real GDP.
- If nominal GDP grows 6% and inflation is 2%, what is real growth?
- Why is real GDP the better measure over time?
