Lesson 4ª


 

 

 

 

 

   

 

NOMINAL GDP v REAL GDP

If we compare the GDP of a country two years apart, we will see differences. These can be due to:

The fact that the GDP has increased or decreased.

Or the prices of products have varied.

Lets look at an example, imagine that a country has a very simple economy as it only produces milk (and that is it - that's its economy).

In 2000 they produced 100 litres of milk, the price of the milk was 1 euro/litre. Therefore, the GDP (2000) was 100 euros.

In 2001 they produced 110 litres of milk, but in this year the price of a litre of milk was 1.2 euros/litre. The GDP (2001) was 132 euros.

If we calculate the growth of the GDP between these two years, we obtain a 32% increase (=132/100) however, if we remove the price variation, the growth is significantly lower.

If we had kept the same price in 2001 as 2000, the GDP would be 110 euros (110 litres at 1 euro/litre). In this case the growth of the GDP would be 10% (=11/100).

In the first example, (growth of 32%) we have compared nominal GDP (each one according to the price of its year) whilst in the second example (increase of 10%) we have compared the real GDP (both GDP measured applying the same price).

The advantage of the real GDP is that it eliminates the distorsion that the variation of prices produces and it indicates how the economy grows and decreases.

How do we calculate the real GDP? You have to apply the following formula:

Real GDP=Nominal GDP / GDP deflator

 

The "GDP deflator" is a price index which collects the variation which has been produced in the level of prices of a country during a determined period. It is an indicator similar to the CPI (Consumer Price Index), but CPI only takes into consideration those goods and services that are intended for the consumer, whilst the "GDP deflator" considers all those goods and services produced in the country.

 

In the previous example, the deflator of the GDP would be 1.2 (=2001 Prices/2000 Prices = 1.2/1)

Then:

Real GDP (2001) = 132 / 1,2 = 110 euros

Exercise: Suppose that the GDP of a country in 1990 is 1000 euros (we are not talking about a superpower) and in the year 2000 it was 1800 euros. The prices in these 10 years have increased by 60% (if we look at the price indicator in 1990 it was 100, and in 2000 it was 160). Calculate the growth of the nominal GDP and the real PIB.


Solution

Change in nominal GDP = 1.800/1.000 = 80% 


Change in Real GDP: 


First we calculate the real GDP for 2000, for that we need to debug the price growth between 1990 and 2000 

GDP deflator: 2000 Rates / Prices 1990 = 160 / 100 = 1.6 

Therefore, real GDP (2001) = 1,800 / 1.6 = 1,125 


Then the change in real GDP = 1.125/1.000 = 12.5%