Short on time? This page is the recap. For explanations and worked examples, use the full study guide.
Recap
- Nominal GDP values output at current prices. It measures how much is spent on final output.
- Real GDP values output at constant (base-year) prices. It measures how much is produced, with the effect of price-level changes removed.
- Nominal GDP can rise because prices rise, output rises, or both. Real GDP rises only if output rises.
- The GDP deflator is a price index for everything in GDP. Its percentage change is an inflation rate.
- Valuing output at fixed base-year prices can overstate real growth, because fast-growing goods often become relatively cheaper. Agencies use other methods (chain weighting) instead.
Key relationships
| Relationship | Formula | Use it to |
|---|---|---|
| Nominal GDP | Σ (price in year t × quantity in year t) | measure spending on output |
| Real GDP | Σ (base-year price × quantity in year t) | measure output at constant prices |
| GDP deflator | (nominal GDP ÷ real GDP) × 100 | find the price level relative to the base year |
| Real GDP from data | (nominal GDP ÷ GDP deflator) × 100 | convert published nominal figures |
| Growth rate | (new − old) ÷ old × 100 | real growth, nominal growth or inflation |
| Approximation | real growth ≈ nominal growth − inflation | quick check only |
Assumptions behind the numbers
- Only final goods and services are counted (as in Topic 2.1).
- The base year’s prices stay fixed for every year’s real GDP.
- Calculating chain-weighted real GDP is not required; explaining why the base-year method overstates growth is.
Mistakes to avoid
- Judging output from nominal GDP. It can rise while real GDP falls.
- Multiplying by the deflator instead of dividing.
- Inverting the deflator ratio: nominal goes on top.
- Using current prices when calculating real GDP.
- Reading a deflator level as an inflation rate. 112 means 12% above the base year, not 112% inflation.
- Assuming real GDP is always below nominal GDP. It is above nominal GDP whenever the deflator is below 100 (for example, before the base year if prices have been rising).
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- Nominal GDP is VD 540 billion and the deflator is 108. What is real GDP? (VD 500 billion)
- Nominal GDP is VD 460 billion and real GDP is VD 400 billion. What is the deflator? (115)
- The deflator rises from 110 to 115.5. What is the inflation rate? (5%)
- Real GDP equals nominal GDP. What do you know about that year? (It is the base year, or prices are at base-year levels: deflator = 100.)
Next: practice questions.