Nominal and real GDP Nominal GDP: is the value of goods and services measured at current prices. It can change over time, either because there is a change in the amount of goods and services or a change in the prices of those goods and services. Real GDP: is the value of goods and services measured using a constant set of prices. OR it is an inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices. With nominal GDP, it is noticeable that GDP can increase either because prices rise or because quantities rise. So, GDP computed in this way is not a good gauge (measure) of economic well-being. Example, if all prices doubled without any change in quantity, GDP would double. That is why having real GDP is important, because the prices remain stable. Bzhar N. Majeed

Nominal and real GDP Nominal GDP (P * Y)= P1 current * Q1 current + P2 current * Q2 current + ……….. Real GDP (Y) = P1 base * Q1 current+ P2 base * Q2 current+ …….. Base year is 2011 Final good P 2011 ($) Q 2011 P 2012 Q 2012 Nominal GDP contribution ($) Real GDP contribution ($) 2011 2012 Bread 3 100 4 125 Butter 2 50 2.50 60 Total Bzhar N. Majeed

Nominal and real GDP The percentage change in Real & Nominal GDP % change = [(final – initial)/initial] * 100% % change in Nominal GDP = [(650-400)/400] * 100% = 62.5% The 62.5% is an average of the growth rates for both goods, which is attributable to the increase of both quantities and prices. % change in Real GDP = [(495-400)/400] * 100% = 23.75% So, 23.75% is an average of the growth rates for both goods, which is attributable to the increase in the quantities produced only. Bzhar N. Majeed

GDP Deflator GDP deflator = Nominal GDP / Real GDP * 100 It is an index that measure how the prices of goods and services included in GDP change over time. OR, it is a measure of the change in prices of goods newly produced within a country over the course of a specific time period. The basic idea is that the differences between nominal GDP and real GDP for any year arise only because of changes in prices. So, by comparing real and nominal GDP we can measure the changes in price for the economy. In practice we do this by creating an index, called the GDP deflator. GDP deflator = Nominal GDP / Real GDP * 100 Bzhar N. Majeed

GDP Deflator GDP deflator for year 2011 = 400 / 400 * 100 = 100 Because the value of GDP deflator was 131 in 2012 and was 100 in the base year of 2011, this means prices rose by 31 percent between the two years: Inflation from year1 to year2, OR (inflation rate in year 2) = % change in GDP deflator [(GDP def. y2 – GDP def. y1) / GDP def. y1] * 100% (131-100)/100 * 100% = 31/100 = 0.31 0.31 is a weighted average of the price changes for the two goods (bread and butter). There was an aggregate increase in the price level of our goods by 31% caused the inflation Bzhar N. Majeed