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Example Nominal and Real GDP
The nominal GDP of Ayeland is $5.0 billion for 20X1. In 20X2, Ayeland’s nominal GDP is measured at $5.5 billion. The inflation rate for 20X2 was 6%.What was the real GDP growth of Ayeland in 20X2?
Answer:
Ayeland’s 20X2 nominal GDP (including inflation effects) is $5.5 billion, an increase of 10% from 20X1.However, since the inflation rate was 6% for the period, Ayeland’s real GDP is calculated as follows:
Real GDP
= Nominal GDP / (1 + inflation rate %)
= $5.5 billion / (1 + 6%)
= $5.5 billion / (1.06)
= $5.19 billion
The summary of Ayeland’s GDP growth is as follows:
Nominal GDP Real GDP
Year 20X1 $5.00 billion $5.00 billion
Year 20X2 $5.50 billion $5.19 billion
Growth % 10.0% 3.8%
([5.5 / 5.00] – 1) ([5.19 / 5.00] -1)I understand the calculation and formula but I don’t get why they have calculated Price index of Real GDP by comparing current year’s Real GDP (without inflation effect) with last year’s Nominal GDP (including inflation effect). Isn’t the 3.8% an unreliable measure as the last year’s nominal GDP includes inflation effect in itself? Should they have not compared like with like, in this case Real GDP of current year with last year’s Real GDP instead of Nominal GDP?
Despite what thw answer might say, there is no such thing as a real or nominal GDP. The GDP is an absolute number and is measured in $ (or whatever currency you want).
Nominal, real and inflation are all measured as percentage changes, or rates. The nominal rate is also known as the ‘Money rate’, ie how much the flows of money have increased…but you have to take inflation into account to know how much better off you really are, ie the real rate.
The relationship is:
1 + Nominal rate (or money rate) = (1 + Real rate) x (1 + Inflation rate).
In the example:
Nominal rate = 10%
Inflation rate = 6%So: 1 + 0.1 = (1 + 0.6) x ( 1 + real rate)
1 + real rate = 1.1/1.06 = 1.038
So real rate is 0.038 or 3.8%.
HTH
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