What is Nominal Gross Domestic Product (Nominal GDP)?
Nominal Gross Domestic Product (Nominal GDP) is the total market value of all goods and services produced in a country’s economy over a given period. Unlike other GDP measurements, nominal GDP is not adjusted to account for price changes from inflation and deflation.
It means that it rises and falls (usually rises) with the change in price and economic output in an economy. In the real world, the nominal GDP is usually used to compare GDP to other economic variables that do not adjust for inflation, including debt.
Key Difference Between Nominal GDP and Real GDP
Real GDP is another measurement of economic activity but differs slightly from nominal GDP in use and measurement.
Nominal GDP is an economic measure that does not account for changes in the price level. In other words, it is the market value of all final goods and services in an economy over a period. If prices were to change, but the economic output was to remain constant, then the nominal GDP would change – that is why the metric is sometimes misleading to economists and investors.
In contrast, real GDP accounts for changes in price that may occur due to inflation or deflation. A simpler way to understand real GDP is to think of it as nominal GDP that’s been adjusted for changes in price.
Real GDP will either use the prices in a base year or a GDP Deflator to account for the changes in price. In doing so, economists and investors can gain a better idea of the real change in economic activity in a given period.
Some common misconceptions about nominal GDP are:
1. An increase in nominal GDP means an increase also in economic activity.
Since nominal GDP accounts for all final goods and services in an economy at current market prices, growth in this economic measure can be attributed to either an increase in quantity or price.
As such, it is hard to determine which of these factors is responsible for the increase in nominal GDP, so economists and investors will usually adjust it to account for the change in price levels.
2. It is easy to compare nominal GDP measures over time.
When comparing GDP figures from different time periods, economists and investors will usually use real GDP because it removes changes in prices that might have occurred (which shows the real change in economic output).
It would be difficult to use nominal GDP because it considers the change in economic output and prices. However, economists and investors will use nominal GDP when comparing economic output in different quarters within the same year.
Calculating Nominal Gross Domestic Product
There are a few ways to calculate the nominal Gross Domestic Product:
1. Expenditure Approach
GDP = C + I + G + (X – I)
- C = Consumer Spending: The total amount of spending that individuals spent on goods and services for personal use
- I = Business Investment: The amount of business investment that is spent to invest in new capital improvements or business expansions
- G = Government Spending: The amount of government spending present in the economy, including on new infrastructure
- (X – I) = Net Exports: The amount a country gains on exports minus how much it spends on imports
The expenditure approach accounts for both quantity changes and prevailing market prices, and thus, is a suitable way to measure nominal GDP.
2. GDP Deflator Approach
Nominal GDP = Real GDP x GDP Deflator
- Nominal GDP: An economic measure that measures the value of all economic outputs at the prevailing market prices
- Real GDP: An economic measure that accounts only for the change in quantity output
- GDP Deflator: A measurement of the change in price over a duration of time (inflation or deflation). It is calculated as the ratio of Nominal GDP to Real GDP.
The GDP Deflator approach requires knowledge of the real GDP level (output level) and the change in price (GDP Deflator). When you multiply both elements, the result is the nominal GDP.
GDP Deflator: An In-depth Explanation
The GDP Deflator tracks price changes in a country’s economy over time. It will take a base year, where nominal GDP equals real GDP, and sets it equal to 100. Any change in price will be reflected in nominal GDP, which will lead to a change in the GDP Deflator.
For example, if the GDP Deflator is 112 the year after the base year, then it indicates that the average price of the output increased by 12%.
Let’s say a country only produces one type of good – it follows the yearly schedule below for both quantity and price.
Nominal GDP is derived by multiplying the current year quantity output by the current market price. In the example above, the nominal GDP in Year 1 is $1000 (100 x $10), and the nominal GDP in Year 5 is $2250 (150 x $15).
The information above tells us that between Year 1 and Year 5, GDP could’ve increased because of prices (prevailing inflation) or the quantity output. Further analysis would be required to derive the root cause of the GDP increase.
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