Lesson preview · Nominal Vs Real Gdp
Nominal vs Real GDP
~10 min · Free to read
In 1980, US GDP was about 2.9 trillion dollars. In 2023, it was about 27.4 trillion. Did the US economy grow nearly tenfold in 43 years? Not even close. Most of that increase was prices going up. Strip out inflation and the real expansion was about three-fold, not ten.
Mixing up price growth with output growth is the single most common mistake in reading economic statistics. GDP measured at the prices that prevailed at the time is called nominal GDP. GDP measured at the prices of a fixed base year is called real GDP. The difference matters a lot.
Key Term
Nominal GDP
GDP measured at the current year’s prices. If prices rise, nominal GDP rises — even if production didn’t change.
Key Term
Real GDP
GDP measured at the prices of a fixed base year. Real GDP only changes when actual production (quantity) changes — price moves are stripped out.
Set price growth to +10% and leave output growth at 0: the green stays level with the dashed line (real GDP flat) and the whole increase is the amber cap — nominal up, real unchanged, the deflator catching all of it. Now flip it — output growth +10%, price growth 0: the green climbs above the line with no amber cap, so nominal and real grow together and the deflator stays at 100. Real GDP is the part you care about when you’re asking whether the economy is actually producing more.
Key Term
The GDP deflator
A price index that comes out of the GDP data itself. Formula: Nominal GDP ÷ Real GDP × 100. Set to 100 in the base year by construction. A deflator of 130 means prices have risen 30 percent above the base year.
The deflator is the ratio of nominal to real GDP, scaled to a base of 100.
From the deflator we get the GDP-deflator inflation rate. It’s just the percent change in the deflator from one year to the next:
Inflation rate using the GDP deflator — exactly the percent-change formula applied to the deflator.
Trap · Common Misconception
Nominal growth ≠ real growth
If you read “US GDP grew 6 percent last year,” check whether it’s nominal or real. In 2021, US nominal GDP grew about 10.7 percent — but inflation that year was about 4.7 percent. Real GDP grew about 5.7 percent. The headline number can wildly overstate how much more stuff the economy produced. Always look for the word real.
Tip
Three ways to convert between nominal and real
Given any two of {Nominal GDP, Real GDP, Deflator}, you can find the third:
- Real = Nominal ÷ (Deflator/100)
- Nominal = Real × (Deflator/100)
- Deflator = (Nominal ÷ Real) × 100
This is how the Bureau of Economic Analysis builds its data series. Pick any year as the base year, and you can express the entire history of the economy in constant prices from that anchor.
Check yourself · no marks
An economy’s nominal GDP grew 8% last year. Its GDP deflator grew 5%. Approximately how much did real GDP grow?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Worked Example
An economy makes only apples and laptops. In Year 1 (the base year), apples are 1 dollar each and laptops are 1,000 dollars each. The country produces 100 apples and 10 laptops. In Year 2, apple prices double to 2 dollars and laptop prices stay at 1,000. Production is unchanged. Find nominal GDP and real GDP in Year 2, and compute the deflator.
Practice · 1 / 4
An economy’s nominal GDP doubled over a decade. Real GDP grew 20%. What can you conclude?
Next
Like what you read?
Sign up free to save your progress, get spaced reviews tuned to you, and unlock all 50 microeconomics knowledge points with interactive graphs and adaptive practice.