Nominal Gross Domestic Product

Nominal GDP is GDP using current quantities and current dollars. It is calculated by multiplying the number of products by their current prices. An increase in nominal GDP does not necessarily represent an increase in production. If prices double from one year to another and production remains the same, nominal GDP will double.

Real Gross Domestic Product

Real GDP is GDP using current quantities and so-called constant dollars. It is calculated by multiplying the number of products by constant prices from a base year. For example, we can select the year 2000 as the “base year,” and calculate real GDP in other years by using prices from the year 2000. Real GDP, thus, only measures the changes in the volume of production. This is a better indicator of economic activity and economic health.

Example Problem: Let’s suppose that a very small country makes only two commodities: pizzas and smart phones. The country bakes 200 pizzas at $10 each in year 1. In that same year, it manufactures 100 smart phones at $50 each.

In year 2, the country makes 190 pizzas and 110 smart phones at respective prices of $12 and $60 each. Image result for public domain image of smartphoneUsing year 1 as the base year for calculating real GDP, what are nominal and real GDP for each year?

The solution is given in the table below:

Production and Prices Year 1 Nominal GDP Year 2 Nominal GDP Year 1 Real GDP Using Year 1 Prices Year 2 Real GDP Using Year 1 Prices
200 pizzas at $10 each (year 1) $2,000
plus
$2,000
plus
100 smart phones at $50 each (year 1) $5,000 equals: $5,000
equals:
$7,000 $7,000
190 pizzas at $12 each (year 2) $2,280
plus
$1,900 (190 times $10)
plus
110 smart phones at $60 each (year 2) $6,600 equals: $5,500 (110 times $50)
equals:
$8,880 $7,400

The above table shows that nominal GDP rises from $7,000 in year 1 to $8,880 in year 2. Real GDP also rises, but not by as much (because of the adjustment for price increases). It is $7,000 in year 1, and rises to $7,400 in year 2.

Video Explanation
For a video explanation of how to calculate real and nominal Gross Domestic Product, please watch the following:

The Fisher Formula

Recently, The U.S. government has used a different way to calculate real GDP. Instead of using a certain base year for calculation of real GDP of all years, a so-called “Fisher formula” that incorporates price and quantity weights from two adjacent years or quarters, is used. These annual or quarterly changes are “chained” (multiplied) together to form time series of quantity and price indexes. For more information, click here for Bureau of Economic Analysis GDP calculations and explanations: (http://www.bea.gov). For our purposes, the idea or concept of the difference between nominal and real GDP is the same whether you use base years or chained weights.

As of 2012, the United States government also added research and development and artistic works to the GDP. This has resulted in higher numbers for GDP for this year. All previous years were also adjusted to reflect this change (see table below).

United States Nominal and Real GDP Throughout the Years

The table below shows United States Bureau of Economic Analysis selected annual nominal and real GDP data for the United States from 1930 through 2015, in chained year 2009 dollars rounded to the nearest whole dollar amount (in billions). Both nominal and real GDP in the United States have grown considerably over the decades. Due to the housing/financial crash in 2008, real GDP fell from 2008 to 2009, but grew again after 2009.

Year United States Gross Domestic Product in billions of current dollars (nominal GDP) United States Gross Domestic Product in billions of chained 2009 dollars (real GDP using 2009 prices)
1930 92 966
1940 103 1265
1950 300 2181
1960 543 3,105
1970 1,075 4,717
1980 2,862 6,443
1990 5,979 8,945
2000 10,289 12,565
2001 10,625 12,684
2002 10,980 12,909
2003 11,512 13,270
2004 12,277 13,774
2005 13,095 14,235
2006 13,857 14,615
2007 14,480 14,876
2008 14,720 14,833
2009 14,417 14,417
2010 14,958 14,779
2011 15,533 15,052
2012 16,244 15,471
2013 16,768 15,710
2014 17,419 16,085
2015 18,036 16,397

Source: www.bea.gov.