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Nominal GDP: Definition & Formula
What is Nominal Gross Domestic Product (GDP)?
Nominal Gross Domestic Product (GDP) is the total economic output of a nation using current prices. In other words, it is the measurement of all the goods and services a country produces, in prices, at the time they are made. For example, a bag of chips would have sold for a few cents back in the 1980s. Those few cents would classify as nominal GDP. Today, those same bags of chips are worth over $2. Again, that $2 is counted within the calculation.
So nominal GDP considers all the goods and services produced at the time it was made or sold. It highlights economic growth, but only in current values. So if the price of a bag of chips increases by 5 percent, it would see an increase in economic output by the same amount. The issue with this is that it not only factors in the growth of economic output but also increases prices.
Key Points
- Nominal GDP is the economic output of a nation based on current prices.
- Its value includes price increases due to inflation.
- It differs from Real GDP in the fact that it includes changes to prices due to inflation, whilst Real GDP factors it in.
Nominal GDP is the most basic form of economic measurement. It takes all the goods and services the economy produces and provides a monetary value for such.
For example, in year 1, the US produces 100 apples which are worth $50 in total. This is the only thing it produces, so its nominal GDP is $50. In year 2, it produces 100 apples again, but due to inflation, these are now worth $55 – an increase in prices by 10 percent. The value in year 2 is $55 as it considers current prices.
Although there was no increase in the production of apples, it would suggest that there was a 10 percent increase in economic growth – because inflation was not considered.
How to Calculate Nominal GDP
Nominal GDP can be calculated using the formula:
Quite simply, it is Gross Domestic Product using current prices. So it factors in both growth in quantity and prices. For example, the US produces 100 motor vehicles in year 1 at a value of $2.5 million. In year 2, it produces 110 cars at a price of $3 million.
Year 1 Nom GDP = $2.5 million
Year 2 Nom GDP = $3 million
In this example, nominal GDP has increased by 20 percent. However, the production of cars has only increased from 100 to 110 – which is 10 percent. So although we can see output has increased, we can also see that a proportion of the increase in nominal GDP is attributable to an increase in prices.
Nominal GDP Calculator
Effects of Inflation on Nominal GDP
1. Increase in Value
Nominal Gross Domestic Product (GDP) is an economic measurement that looks at the nations output using current prices. This means that it doesn’t include inflation in its calculation, which has an effect on its measurement.
When inflation occurs, the value of money decreases. This means that $10 today will not buy the same number of goods the year after. In turn, this has a significant effect on nominal GDP.
As a result of inflation, a nations GDP may increase quite rapidly. This may seem like the nation is achieving good economic growth. However, without that level of inflation, the economy may in fact be in a recession. This is because the increase in economic output is due to an increase in prices rather than the number of goods produced.
2. Distorts economic data
One of the effects that inflation has is that it can distort economic data. Through inflation, it makes it difficult to see how various countries are performing against each other. Without factoring in inflation, it may seem like one nation is experiencing rapid growth, whilst another is in stagnation. Yet this may be due to inflation which factors in prices rather than quantity of goods.
Over time, the effects of inflation can make this data redundant. This may be 10, 20, or 30 years time, whereby it may seem that the economy has achieved rapid economic development. Yet when nations experience consistent levels of inflation, these rates of growth can seem misleading. What may look like strong, steady growth, may just in fact be price increases and not growth in the production of goods.
3. Decrease in purchasing power
Inflation decreases the purchasing power of consumers. When prices become higher, consumers cannot afford the same number of goods – thereby affecting economic output. This is because consumers start to demand fewer goods and services. In turn, this can lead to further economic decline if layoffs result, causing an even further decline in demand.
With inflation affecting demand, businesses have a few options. It can accept lower profits, cut costs through redundancies, reduce production, and reduce investment. All of which have a detrimental impact on the overall economy.
In conclusion, inflation has a significant effect on nominal GDP in a number of ways. These include, artificially increasing GDP, distortion of economic data, and a decrease in purchasing power of consumers. All of which contribute to actually decreasing economic output. In turn, policymakers and investors pay great credence to inflation as an economic tool, noting its importance to overall economic growth.
Nominal vs Real GDP
The main difference between nominal and real GDP is that real GDP is adjusted for inflation, whilst the nominal GDP includes both economic growth as well as increases in prices. For example, in year 1, Country X produces 50 apples, 30 pears, and 20 bananas for a total of $500 – which is its nominal GDP. In year 2, it produces 60 apples, 35 pears, and 22 bananas for a total of $700.
Year 1 Nom GDP = $500
Year 2 Nom GDP = $700
This shows that nominal GDP increased by 40 percent in the year. However, it doesn’t consider the impact that inflation has had. In other words, how much of that growth is attributable to increases in economic efficiency and productivity.
During the period, inflation was 5 percent. Real GDP would therefore factor this in.
Year 1 Real GDP = $500
Year 2 Real GDP = $700 / (1.05 aka 5 percent) = $667
Once inflation is considered, we can see that the true economic growth – so the increase in the number of goods produced – is 33.4 percent.
FAQs
It is the total economic output of a nation using current prices, without adjusting for inflation.
Nominal Gross Domestic Product (GDP) is calculated with the formula: Nom. GDP = C + I + G + X, where C = Consumption, I = Private Investment, G = Government spending, and X = net exports (exports – imports).
Nominal Gross Domestic Product (GDP) calculates economic output at current prices, whilst real GDP uses constant prices which accounts for inflation.
It is an importance economic measurement as it tracks a nations current economic output. This can help policymakers make better informed decisions as the health of the economy can play a factor in what best course of action to take.
Whilst it does have many drawbacks, it is a useful tool which can also be used to create other important measurements such as real GDP.
When GDP is growing, it can impact investors overall perception on the health of companies. In growth, it indicates demand is strong and therefore companies will experience robust demand for their goods. This can help send stock prices higher as investors are confident in the firms ability to turn a profit. After all, it’s easier to make money when the economy is doing well.
About Paul
Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.
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