21.4 Real and Nominal GDP
U.S. GDP has doubled since the end of the last century. In 2018, it was $20.5 trillion, compared to 2000 when it was $10.25 trillion. But total economic activity didn’t double over this period. The problem is that the market value of total production can double because we’re making twice the quantity of stuff, or because we’re making the same quantity of stuff but market prices are twice as high. Or, as in this case, it can reflect some combination of rising prices and rising quantities. It’s a distinction that matters, because an increase in the quantity of stuff we produce raises living standards, while a change in the price tags attached to that stuff doesn’t change anyone’s quality of life.
Real and Nominal GDP
Nominal GDP is GDP measured in today’s prices. To calculate nominal GDP you add up the market value of total production in a year using the current prices prevailing in that year. Nominal GDP is useful if you want to know what GDP is right now, based on the prices that you face right now. However, nominal GDP is not very useful for making comparisons over time. The problem is that when prices rise over time—a process known as inflation (which we’ll explore in Chapter 24)—nominal GDP will rise even when actual production is unchanged. For instance, nominal GDP values last year’s apple crop at last year’s price (say, $1 per pound), while this year’s nominal GDP will value apples at this year’s price of $2 per pound. If we produce the same number of apples but count this year’s apples as if they’re twice as valuable, it appears that apples’ contribution to GDP has doubled even though actual apple production is unchanged.
When you’re trying to evaluate changes over time in economic activity, you should analyze real GDP instead. Real GDP is GDP measured in constant prices, so that it excludes the effects of price changes. By focusing only on changes in GDP due to changes in the quantity of output produced, real GDP isolates economic growth. It’s calculated by adding up GDP as if no prices changed between last year and this year. It’s called real GDP to remind you that it measures the real change in production, rather than changes in the price tags attached to each product.
When economists talk about GDP growth they nearly always mean “growth in real GDP.” In fact, most people who talk about changes in GDP are referring to changes in real GDP. So when you see a CNN report that the “U.S. economy grew 2.3% last year,” you can safely assume it’s describing real GDP.
How to Calculate Real GDP
You’ll better understand the distinction between real and nominal GDP by seeing how they’re calculated. In order to make the numbers as simple as possible, we’ll calculate GDP growth as if Crate & Barrel were the only business in the whole economy. (Expanding this example to include the rest of the economy won’t change anything beyond making the calculations more complicated.)
Figure 10 gives the key inputs to our calculations, for both “last year” when 100 couches were sold at a price of $1,500 each, and “this year,” when 103 couches were sold at a price of $1,530 each. Over these two years, the average price, 
Figure 10 | Calculating Real and Nominal GDP
Calculate nominal GDP using current prices.
Nominal GDP is calculated as the market value of total output in each year, where each year’s output is valued based on the market price in the year it was produced. So in this example, nominal GDP grew from 
Calculate real GDP using constant prices.
Real GDP is calculated by computing growth in the value of output between this year and last year, where that output is valued using an unchanging, or constant, set of prices. As a result, it’s sometimes referred to as GDP at constant prices. To be precise, GDP growth between any pair of adjacent years is calculated using the average price level over those two years. (This is part of a procedure known as chain-weighting, which calculates the growth in real GDP over time by first calculating growth between pairs of adjoining years using the average price in that specific pair of years, and then chaining together or accumulating these year-to-year growth rates to estimate growth over longer periods.)
So in our example, we calculate real GDP as if the price were constant at its average level over these two years of $1,515. As a result, we compute that real GDP grew from 
Do the Economics
Last year, Dell sold 100 laptops at $1,000 each, and this year, it sold 104 laptops at $1,060 each. Calculate (a) the growth rate of prices; (b) the growth rate of Dell’s contribution to nominal GDP; and (c) the growth rate of Dell’s contribution to real GDP.
There’s a trick that will let you move quickly between real and nominal GDP growth.
If you had to do calculations like this all the time, it would quickly become tiresome. But there’s a simple math trick that makes it a lot simpler. For changes over short periods of time (perhaps a few years):
In Figure 10, real GDP rose by 3%, and the price of couches rose by 2%, and so this formula correctly predicts that nominal GDP rose by 5%.
If you rearrange a bit, this also gives you a way to calculate growth in real GDP:
Thus, the growth rate of real GDP is simply the growth rate of nominal GDP, less the average growth rate of prices. In Chapter 24, we’ll describe a general rise in prices as inflation and the specific measure of inflation used to estimate real GDP is called the GDP deflator.
Do the Economics
- In 2018, nominal GDP grew 5.2%, and prices rose by 2.3%. Calculate the growth rate of real GDP.
- Head to https://fred.stlouisfed.org and find the growth rate of nominal GDP last year, as well as the growth rate of the GDP deflator. Calculate growth in real GDP.
Finally, I bet you’ve noticed that macroeconomics often involves unimaginably large numbers—such as the $20.5 trillion worth of U.S. GDP. Our last task is to develop some strategies you can use to make sense of these huge sums.