What is nominal gross domestic product?
Nominal gross domestic product is gross domestic product (GDP) valued at current market prices. GDP is the monetary value of all goods and services produced in a country. The nominal differs from real GDP in that it includes price changes due to inflation, which reflects the rate of price increase in an economy.
Key points to remember
- Nominal GDP is an assessment of economic output in an economy but includes the current prices of goods and services in its calculation.
- GDP is generally measured as the monetary value of the goods and services produced.
- Since nominal GDP does not suppress the rate of price increase when compared from one period to another, it can inflate the growth figure.
Nominal GDP vs real GDP
Understanding nominal gross domestic product
Nominal GDP is an assessment of economic output in an economy that includes current prices in its calculation. In other words, it does not suppress inflation or the rate of increase in prices, which can inflate the growth figure. All goods and services accounted for in nominal GDP are valued at the prices actually sold during this year.
Effects of inflation on nominal GDP
Because it is measured at current prices, nominal GDP growth from year to year could reflect higher prices as opposed to an increase in the quantity of goods and services produced. If all prices rise more or less together, known as inflation, this will make nominal GDP appear higher. Inflation is a negative force for economic actors because it decreases the purchasing power of income and savings, both for consumers and for investors.
Inflation is most often measured using the consumer price index (CPI) or the producer price index (PPI). The CPI measures price changes from the buyer’s perspective or their impact on the consumer. The PPI, on the other hand, measures the average change in the selling prices paid to producers in the economy.
When the overall price level of the economy increases, consumers must spend more to buy the same amount of goods. If an individual’s income increases by 10% in a given period but inflation also increases by 10%, the individual’s real income (or purchasing power) remains unchanged. The real term in real income simply reflects income after inflation has been subtracted from the figure.
Nominal GDP vs real GDP
Similarly, if we compare GDP growth between two periods, nominal GDP growth could overestimate growth in the event of inflation. Economists use the prices of goods in a base year to serve as a benchmark when comparing GDP from one year to the next. The price difference between the base year and the current year is called the GDP price deflator.
For example, if prices increased by 1% since the reference year, the GDP deflator would be 1.01. Overall, real GDP is a better measure whenever the comparison spans several years.
Real GDP starts with nominal GDP but takes into account any variation in prices from one period to the next. Real GDP is calculated by taking total output for GDP and dividing it by the GDP deflator.
For example, let’s say the nominal GDP for the current year was $ 2,000,000, while the GDP deflator posted a 1% increase in prices since the reference year. Real GDP would be calculated at $ 2,000,000 / 1.01 or $ 1,980,198 for the year.
One of the limitations of using nominal GDP is when an economy is stuck in a recession or a period of negative GDP growth. The negative growth in nominal GDP could be due to a fall in prices, called deflation. If prices fell at a faster rate than output growth, nominal GDP could reflect an overall negative growth rate in the economy. Negative nominal GDP would mean a recession when in reality output growth was positive.