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How Is Nominal GDP Calculated?
GDP measures the market value of all goods and services produced by a country, which the bureau of economic analysis calculates by multiplying price by quantity.
- In calculating nominal GDP, we only use current quantities at current year prices. This is achieved by using a consumer price index of the country’s basket of goods. Nominal GDP takes into account all the goods and services that are produced within a country’s borders at these current prices.
- If, for instance, the United States produced only three products—coffee, tea, and cannoli, let’s say—nominal GDP would be calculated by first multiplying the quantity of each product produced by its current market price, and then adding the three results together. In order to calculate it, we first need to know the quantity of each product produced and the up-to-date average price for that product.
- Therefore, (coffee quantity x coffee’s current market price) + (tea quantity x tea’s current market price) + (cannoli quantity x cannoli’s current market price) = Nominal GDP
- For instance, the U.S. could have produced 1 million pounds of coffee, which currently sells for $4/lb; 2 million pounds of tea, which currently sells at $2/lb; and 1 million cannoli, which sell for $1/pastry. With this information, we can now calculate this country’s nominal GDP by plugging it into the formula above.
- It can then be further reduced to the nominal GDP per capita by dividing the nominal GDP by the country’s population.
What Does Nominal GDP Measure?
Nominal GDP measures the value of the goods and services produced in a country at current prices, providing a snapshot of a country’s current output in the current moment.
- It tells us the present-day value of a country’s products and services. These prices are invariably affected by inflation, so nominal GDP provides an up-to-date account of the real-world value of a country’s goods and services.
- Because it accounts for current prices affected by inflation, it is not an accurate measure of GDP growth rate, or the increase/decrease of a country’s production and output over a given time period, because it is heavily influenced by inflation, which occurs regardless of a country’s production volume. This means that it is possible for a country’s nominal GDP to rise—due solely to inflation—even as their output drops.
- This is why it is best used as a snapshot of current value as opposed to a year-over-year measure of production.
What Is the Effect of Inflation on Nominal GDP?
Inflation will cause nominal GDP to rise, meaning that in looking at year-over-year changes, a rise in nominal GDP does not necessarily reflect economic growth but rather reflects the inflation rate within that period.
- For example, if last year the U.S. produced 1.5 million pounds of coffee, which was selling for $2/lb, and this year it produced 1 million pounds of coffee, which currently sells for $4/lb, the nominal GDP will have increased despite the fact that coffee production/sales actually decreased in that period.
- In this case, inflation has caused nominal GDP to rise, even as production has decreased. The inverse could theoretically happen with deflation, meaning that if quantity increases but price level decreases, nominal GDP could decrease even as output has increased.
How Is Nominal GDP Adjusted and Why?
Nominal GDP can be adjusted in two ways to provide a comparison between two countries.
- It can be adjusted to be at an exchange rate to U.S. dollars, meaning that the value of goods across multiple countries will be converted to U.S. dollars and compared effectively.
- It can be adjusted through purchasing power parity (PPP) by comparing baskets of goods that only include items produced in both countries (literally be comparing apples to apples) and then finding a purchasing power parity exchange rate by comparing the cost in different currencies.
However, it is important to remember that nominal GDP is not adjusted to account for inflation but is merely a calculation of the quantity of goods multiplied by their current prices. When nominal GDP is adjusted to account for inflation, it becomes real GDP, which can then be used to understand the percentage of change over time to a country’s economic output. This is achieved by using a past year as a base year and comparing that base year to the current year’s real GDP.
How Does Nominal GPD Compare to Real GDP?
While nominal GDP by definition reflects inflation, real GDP uses a GDP deflator to adjust for inflation, thus reflecting only changes in real output. Since inflation is generally a positive number, a country’s nominal GDP is generally higher than its real GDP.
- Economists typically use nominal GDP when comparing different quarters of output within the same year.
- But when comparing GDP across more than one year, economists use real GDP because, by removing inflation from the equation, the comparison only shows the change in output volume between the years. That means that real GDP growth reflects a country’s increased output and is not influenced by inflation increasing price level.
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