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Nominal GDP vs Real GDP

Nominal GDP vs Real GDP

Want to know how to find out whether the economy is growing? What are some metrics that show how well the economy is? Why do politicians like to avoid talking about real GDP instead of GDP? You will know how to answer all these questions once you read our Real vs. Nominal GDP explanation.

Difference between Nominal and Real GDP

To know if the economy is growing or not, we need to determine if the increase in GDP is due to a rise in output (goods and services produced) or an increase in prices (inflation).

This separates economic and financial measurements into two categories: Nominal and real.

Nominal means in current prices, such as the prices you pay whenever you make a purchase. Nominal GDP means that year's final goods and services are produced multiplied by their current retail prices. Everything that is being paid today, including interest on loans, is nominal.

Real means adjusted for inflation. Economists take the prices according to a set base year to adjust for inflation. A base year is usually a recent year in the past chosen to illustrate how much growth has occurred since then. The term "in 2017 dollars" means that 2017 is the base year and that the real value of something, such as GDP, is being shown - as if prices were the same as in 2017. This reveals whether or not output has improved since 2017.

If the actual value of the current year is greater than the base year, growth has occurred. If the actual value of the current year is smaller than the base year, it means that negative growth, or loss, has occurred. In terms of GDP, this would mean a recession (two or more consecutive quarters - three month periods - of negative real GDP growth).

Real and Nominal GDP definition

The bottom line is that the difference between nominal GDP and real GDP is that nominal GDP is not adjusted for inflation. You can see a rise in nominal GDP, but it could be simply because the prices are rising, not because more goods and services are produced. Politicians love talking about nominal GDP numbers, as it points to a 'healthier' picture of the economy instead of real GDP.

Nominal Gross domestic product (GDP) measures the dollar value of all final goods and services produced within a nation during a year.

Typically, GDP rises every year. However, this does not necessarily mean that more goods and services are being created! Prices tend to increase over time, and the general increase in the price level is called inflation.

Some inflation, around 2 percent per year, is normal and expected. Inflation above 5 percent or so may be considered excessive and harmful because it represents a substantial decrease in the purchasing power of money. Very high inflation is known as hyperinflation and signals a runaway excess of money in an economy that is causing prices to rise consistently.

Real GDP doesn't account for the price level and is a good metric to see how much growth a country experiences on an annual basis.

Real GDP is used to measure the growth in goods and services in the economy.

Examples of Real and Nominal GDP

When the news reports a nation’s economic growth and the size of its economy, it is usually doing so in nominal terms.

The nominal GDP of the United States was approximately $23 trillion in 20211. On the other hand, the real GDP in the U.S for 2021 was slightly below $ 20 trillion2. When looking at growth over time, it may be essential to use real GDP to make the numbers more manageable. By adjusting all annual GDP values to a fixed price level, graphs are more visually understandable, and correct growth rates can be determined. For example, the Federal Reserve uses 2012 as a base year to show proper real GDP growth from 1947 to 2021.

In the example above we see that the nominal GDP can be drastically different from the real GDP. If inflation isn't subtracted the GDP would appear 15% higher than it actually is, which is a very large margin of error. By finding the real GDP economists and policymakers can have better data on which to base their decisions.

The Formula for Real and Nominal GDP

The formula for nominal GDP is simply current output x current prices. Unless otherwise stated, other current values, such as income and wages, interest rates, and prices, are assumed to be nominal and have no equation.

The output represents the overall production that takes place in the economy, whereas prices refer to the prices of each good and service in the economy.

If a country were to produce 10 apples that sell for $2 and 15 oranges that sell for $3, then the nominal GDP of this country would be

Nominal GDP = 10 x 2 + 15 x 3 = $65.

However, we must adjust for inflation to find real values, which means removing them by either subtraction or division.

Knowing the inflation rate lets you determine the rate of real growth from nominal growth.

When it comes to the rate of change, the ability to find the real value is simple! For GDP, interest rates, and income growth rates, the real value can be found by subtracting the inflation rate from the nominal rate of change.

Nominal GDP growth - inflation rate = real GDP

If nominal GDP is growing by 8 percent and inflation is 5 percent, real GDP is growing by 3 percent.

Similarly, if the nominal rate of interest is 6 percent and inflation is 4 percent, the real rate of interest is 2 percent.

If the inflation rate is greater than the nominal growth rate, you lose value!

If nominal income increased by 4 percent annually and inflation was 6 percent annually, one's real income actually decreased by 2 percent or a -2% change!

The -2 value found using the equation represents a percent decrease. Therefore, one should be aware of the inflation rate when negotiating for wage increases to avoid losing real income in the real world.

However, to find the dollar value of real GDP, you must use the prices of a base year. Real GDP is calculated by using the prices of a base year and multiplying them by the total amount of goods and services produced during the year you want to measure its real GDP. The base year in this case is the first year of a GDP in a series of GDP years measured. You can think of the base year as an index that tracks changes in GDP. This is done to remove the impact that prices have on GDP.

Economists compare the GDP to the base year to see whether it has increased or decreased in percentage terms. This method allows you to track the base year's growth in goods and services. Usually, the year chosen as a base year is a year that didn't have extreme economic shock, and the economy was functioning normally. The base year is equal to 100. That's because, in that year, the prices and output in nominal GDP and real GDP are equal. However, as the base year prices are used to calculate real GDP, while output changes, there is a change in real GDP from the base year.

Another way to measure the Real GDP is using the GDP deflator as seen in the formula below.

The GDP deflator basically tracks the change in price level for all goods and services in the economy.

The Bureau of Economic Analysis provides the GDP deflator on a quarterly basis. It tracks inflation using a base year which is currently 2017. Dividing Nominal GDP by GDP deflator removes the effect of inflation.

Calculation of Real and Nominal GDP

To calculate the nominal and real GDP, let's consider a nation that produces a basket of goods.

It makes 4 billion hamburgers at $5 apiece, 10 billion pizzas at $6 apiece, and 10 billion tacos at $4 apiece. By multiplying the price and quantity of each good, we get $20 billion in hamburgers, $60 billion in pizzas, and $40 billion in tacos. Adding the three goods together reveals a nominal GDP of $120 billion.

This seems like an impressive number, but how does it compare to a previous year when prices were lower? If we have a previous (base) year's quantity and prices, we can simply multiply the base year's prices by the current year's quantities to get real GDP.

Nominal GDP = (current quantity of A x current price of A) + (current quantity of B x current price of B) +...

Real GDP = (current quantity of A x base price of A) + (current quantity of B x base price of B+)...

However, sometimes you do not know the base year's quantities of goods and must adjust for inflation only by using a provided change in prices! We can use the GDP deflator to find the real GDP. The GDP deflator is a calculation that determines the increase in prices without a change in quality.

As in the example above, assume the current nominal GDP is $120 billion.

It is now revealed that the current year GDP deflator is 120.

Dividing the current year GDP deflator of 120 by the base year deflator of 100 provides a decimal of 1.2.

Dividing the current nominal GDP of $120 billion by 1.2 reveals a real GDP of $100 billion.

The real GDP will be smaller than the nominal GDP due to inflation. By finding the real GDP, we can observe that the food examples above are quite heavily skewed by inflation. If inflation was not considered, 20 billion GDP would be misinterpreted as growth.

Graphical representation of Nominal and Real GDP

In macroeconomics, real GDP is revealed on many different graphs. It is often the value(Y1) shown by the X-axis (horizontal axis). The most common illustration of real GDP is the aggregate demand/aggregate supply model. It reveals that real GDP, sometimes labeled actual output or real domestic output, is found in aggregate demand and short-run aggregate supply intersection. On the other hand, the nominal GDP is found in the Aggregate demand curve as it represents the total consumption of goods and services in the economy, which is equal to the nominal GDP.

Nominal vs Real GDP Nominal and Real GDP Graph StudySmarter OriginalsFig. 1 - Nominal and Real GDP Graph

Figure 1 shows nominal and real GDP in a graph.

The main difference between the two is that the real GDP measures the overall production that takes place in the economy. On the other hand, nominal GDP consists of the production of goods and services and the prices in the economy.

In the short run, the period before prices and wages can adjust to changes; real GDP may be greater or less than its long-run equilibrium, which is shown by a vertical long-run aggregate supply curve. When real GDP is greater than its long-run equilibrium, often denoted by Y on the X-axis, the economy has a temporary inflationary gap.

Output is temporarily greater than average but will eventually return to equilibrium as higher prices become higher wages and force production to decrease. Conversely, when real GDP is lower than long-run equilibrium, the economy is in a temporary recessionary gap - commonly just called a recession. Lower prices and wages will eventually lead to more workers being hired, returning output to long-run equilibrium.

Nominal GDP vs Real GDP - Key takeaways

  • Nominal GDP is representative of the current total output of a country. Real GDP subtracts inflation from that to determine how much growth in production actually occurred.
  • Nominal GDP measures the total output X current prices. Real GDP measures total output by using a base year to measure the real change in production, this eliminates the effect of inflation in the calculation
  • Real GDP is typically found using final goods and services and multiplying them by the prices from a base year, however, statistical agencies find this can lead to an overstatement, so they actually use other methods.
  • Nominal GDP can be used to find real GDP by dividing it by the GDP deflator
1. Nominal GDP data sourced from, bea.gov2. Real GDP data sourced from fred.stlouisfed.org


Frequently Asked Questions about Nominal GDP vs Real GDP

The difference between nominal GDP and real GDP is that nominal GDP is not adjusted for inflation. 

It depends on what you want to measure. When you want to measure growth in terms and goods and services, you use real GDP; when you also want to take into account price level, you use nominal GDP.

Because it is adjusted for inflation.

The nominal GDP of the United States was approximately $23 trillion in 20211. On the other hand, the real GDP in the U.S for 2021 was slightly below $ 20 trillion.

The formula for nominal GDP is simply current output x current prices. 

Real GDP = Nominal GDP/GDP deflator

Final Nominal GDP vs Real GDP Quiz

Question

What is the difference between real and nominal GDP?

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Answer

The difference between nominal GDP and real GDP is that nominal GDP is not adjusted for inflation. 

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Question

Which is better nominal or real GDP?

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Answer

It depends on what you want to measure. When you want to measure growth in terms and goods and services, you use real GDP; when you also want to take into account price level, you use nominal GDP.

Show question

Question

What are some examples of real and nominal GDP?


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Answer

The nominal GDP of the United States was approximately $23 trillion in 2021. On the other hand, the real GDP in the U.S for 2021 was slightly below $ 20 trillion.

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What is GDP?


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Gross domestic product (GDP) measures the dollar value of all final goods and services produced within a nation during a year.

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What is real GDP?

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Real GDP is used to measure the growth in goods and services in the economy.

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How to define recession in terms of real GDP?

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Answer

Two or more consecutive quarters - three month periods - of negative real GDP growth

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What is the base year the Federal Reserve uses to calculate real GDP?

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2012

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What does nominal mean?

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Nominal means in current prices, such as the prices you pay whenever you make a purchase. Nominal GDP means that year's final goods and services are produced multiplied by their current retail prices.

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If nominal GDP is growing by 8% and inflation is 5%, what is the growth of real GDP?

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Answer

If nominal GDP is growing by 8 percent and inflation is 5 percent, real GDP is growing by 3 percent.  

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What does it mean if nominal GDP has grown by 5% and the inflation rate is 10%?

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In this case the real GDP is equal to nominal GDP minus inflation which equals -5%. That means that the goods and services produced in a country have decreased by 5%.

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What is the formula of real GDP?

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Real GDP = Nominal GDP/GDP deflator

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How do you calculate real GDP using the prices of a base year?

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You multiply the quantity of goods and services for this year by the prices of the base year. That allows you to track growth, separate from inflation.

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Where can you find nominal GDP in the AD-AS model graph?

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Aggregate demand represents also the nominal GDP in an economy.

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Question

Which of the following measures the dollar value of all final goods and services produced within a nation during a year.

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Nominal GDP

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True or False: GDP increasing every year means that more goods are being produced.

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False

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How much inflation is typically targetted?

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2%

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Which of the following occurs when there are extremely high price increases?

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hyperinflation

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If a country were to produce 20 apples that sell for $4 and 45 oranges that sell for $5, then the nominal GDP of this country would be:

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305

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If nominal GDP is growing by 5%, and inflation is growing by 3%, what is real GDP?

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2%

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If nominal GDP is growing by 5%, and inflation is growing by 7%, what is real GDP?

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-2%

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Let's say that in the year 2021, a country was to produce 20 apples that sell for $4 and 45 oranges that sell for $5. In 2020 (the base year), the same country produces 15 apples that sell for $3 and 40 oranges that sell for $2. Find the real GDP of 2021.

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150

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Let's say that in the year 2021, a country was to produce 30 apples that sell for $6 and 50 oranges that sell for $4. In 2020 (the base year), the same country produces 12 apples that sell for $2 and 30 oranges that sell for $3. Find the real GDP of 2021.

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210

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If nominal GDP increases by 12% and real GDP is 2%, what was the inflation rate?

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10%

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True or False: Inflation has no effect on real GDP.

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False

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True or False: Real GDP takes into account inflation to measure the proper amount of growth.

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True

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True or False: Real GDP is represented on the vertical axis on the AD-AS model.

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True

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Everything that is being paid today, is...

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Nominal

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The base year deflator typically equals...

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100

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You can find Real GDP by multiplying the base year prices by...

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current year quantity

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Subtracting nominal GDP by inflation rate will give you...

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Real GDP

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True or False: The GDP deflator basically tracks the change in price level for all goods and services in the economy. 

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True

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To find the dollar value of real GDP, you must use the prices of a ___ year.

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base

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Nominal GDP can be found by multiplying the current years prices and the _______ years quantity.

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current

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