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In episode 20, I spoke of measuring GDP, the country’s income (in a given time period),
which will give us nominal GDP, or the current market value of the goods and services produced,
at that time. But what about real GDP? Perhaps another question first: why should you care?
What does it matter if we use real or nominal GDP?
Let's say that in Year 1, nominal GDP is $10 (or $10 million, or $10 billion…). In Year
2, nominal GDP is $40 (or $40 million, or $40 billion…). Why did GDP increase in Year
2? Well, ideally GDP quadrupled because output of goods and services quadrupled, but that's
not necessarily the case, is it? Couldn't GDP quadruple without having any increasing
output of goods and services produced, but instead, because prices have quadrupled? Or,
probably most realistically, isn’t it possible that the market value of goods and services,
that is, your GDP, quadrupled because there was an increase in output and an increase
in prices? How will we know if the increased value is due to productivity gains, which
would be great, or price increases, which is not so great?
We need to look at real GDP, where adjustments are made to compensate for any changes in
the price level. We could think of real GDP as the sum of all the current final goods
and services produced, but measured in base year prices. If that's real GDP, then we can
think of nominal GDP as the sum of all the current final goods and services produced,
measured in current year prices.
Really then, to get the real GDP from the nominal GDP, you just need to be able to adjust
for any price changes that have occurred since the base year. Note: because GDP contains
more than just typical consumer goods, we can't use the CPI, or consumer price index,
as we had before; we need a broader measure of prices.
The GDP deflator is a price index that includes more goods and services than just the typical
household consumer goods. Do you remember Episode 17, when we looked at real and nominal
versions of an individual's income? The real income was the nominal income, adjusted for
any price changes. Well, this is just a country’s income, so real GDP, the country’s real
income, is the nominal GDP, or the country's nominal income, divided by the GDP deflator
-- our price index -- to adjust for any price level changes.
NEXT TIME: Growth TRANSCRIPT00(MACRO) EPISODE 21: REAL GDP