For more accurate measures, one should use the first formula shown. The distinction is between nominal and real measurements, which refer to whether or not inflation has distorted a given statistic. Based on the nominal interest rates and inflation rates given in [link], in which of the years given would it have been best to be a lender? Economists calculate this change in the value of money using the Consumer Price Index, or CPI, which grants extra weight to the changing prices of the economy's more significant items. Because some people have trouble working with decimals, when the price index is published, it has traditionally been multiplied by 100 to get integer numbers like 100, 85, or 125. It is called the base year (or base period). What was the rate of growth of real GDP from 1960 to 2010? Khan Academy is a 501(c)(3) nonprofit organization. 188.9 / 130.7 * 1.16 = $1.68 Use this data to make another observation: As long as inflation is positive, meaning prices increase on average from year to year, real GDP should be less than nominal GDP in any year after the base year. To convert from nominal interest rates to real interest rates, we use the following formula: real interest rate ≈ nominal interest rate − inflation rate. The nominal value of an economic statistic is the commonly announced value. Looking at economic statistics without considering inflation is like looking through a pair of binoculars and trying to guess how close something is: unless you know how strong the lenses are, you cannot guess the distance very accurately. Whenever you compute a real statistic, one year (or period) plays a special role. To find the real growth rate, we apply the formula for percentage change: In other words, the U.S. economy has increased real production of goods and services by nearly a factor of four since 1960. After all, the dollars used to measure nominal GDP in 1960 are worth more than the inflated dollars of 1990—and the price index tells exactly how much more. With GDP, it is just a tiny bit more complicated. The nominal data series is simply the data measured in current dollars and gathered by a government or private survey. The “prime” interest rate is the rate that banks charge their best customers. When we calculate real GDP, for example, we take the quantities of goods and services produced in each year (for example, 1960 or 1973) and multiply them by their prices in the base year (in this case, 2005), so we get a measure of GDP that uses prices that do not change from year to year. In order to see how much production has actually increased, we need to extract the effects of higher prices on nominal GDP. If an unwary analyst compared nominal GDP in 1960 to nominal GDP in 2010, it might appear that national output had risen by a factor of twenty-seven over this time (that is, GDP of $14,958 billion in 2010 divided by GDP of $543 billion in 1960). Note that using this equation provides an approximation for small changes in the levels. To calculate the real GDP in 1960, use the formula: We’ll do this in two parts to make it clear. By the end of this section, you will be able to: When examining economic statistics, there is a crucial distinction worth emphasizing. To find the real interest rate, we take the nominal interest rate and subtract the inflation rate. Generally, it is the real value that is more important. Let’s return to the question posed originally: How much did GDP increase in real terms? Real Pricez = (Nominal Pricez) x (Adjustment Factor) The adjustment factor is formed using the CPI measures Real Pricez = (Nominal Pricez) x (CPIbase year / CPIz) Here we use the nominal price of 1980 milk ($1.29) and adjust them to the 2000 dollars in order to allow me to directly compare them. Clearly, much of the apparent growth in nominal GDP was due to inflation, not an actual change in the quantity of goods and services produced, in other words, not in real GDP. Use the same formula to calculate the real GDP in 1965. Gross domestic product (GDP) is a measure of aggregate output. The formula used is: Rearranging the formula and using the data from 2005: Comparing real GDP and nominal GDP for 2005, you see they are the same. It is possible to use the data in [link] to compute real GDP. The calculation of the real wage is similar to the calculation of real GDP, only using a different set of variables. So if the nominal GDP is $1200 and the GDP Deflator is 150, the real GDP will be $800 ($1200/150 x 100 = $800). [link] shows the U.S. nominal and real GDP since 1960. Based on the nominal interest rates and inflation rates given in [link], in which of the years given would it have been best to be a borrower? Because some people have trouble working with decimals, when the price index is published, it has traditionally been multiplied by 100 to get integer numbers like 100, 85, or 125. The real value of money describes a sum's value in terms of an earlier reference year's dollars. That is why real GDP is labeled “Constant Dollars” or “2005 Dollars,” which means that real GDP is constructed using prices that existed in 2005. A mortgage loan is a loan that a person makes to purchase a house. OpenStax CNX. Prior to this, a variety of different retail price indices constructed by the Australian Statistician have been used. The price level in 2010 was almost six times higher than in 1960 (the deflator for 2010 was 110 versus a level of 19 in 1960). Similarly, as long as inflation is positive, real GDP should be greater than nominal GDP in any year before the base year. This data is also reflected in the graph shown in [link]. In which years would it have been better to be a person borrowing money from a bank to buy a home? To convert nominal economic data from several different years into real, inflation-adjusted data, the starting point is to choose a base year arbitrarily and then use a price index to convert the measurements so that they are measured in the money prevailing in the base year. Convert the price of a 2-cent stamp in 1902 into its 2002 equivalent: Price of stamp in 2002 dollars = = 2 cents x 180.3 9 = 40 cents Price of stamp in 1902 dollars x CPI in 2002 CPI in 1902. Using the price index growth factor as a divisor for converting a nominal value into a real value, ... (CPI) is applicable to consumers. Then divide into nominal GDP: $543.3 billion / 0.19 = $2,859.5 billion. So for wage earners as consumers, an appropriate way to measure real wages (the buying power of wages) is to divide the nominal wage (after-tax) by the growth factor in the CPI. This conclusion would be highly misleading. Of course, that understates the material improvement since it fails to capture improvements in the quality of products and the invention of new products. First adjust the price index: 19 divided by 100 = 0.19. 22.3 NOMINAL AND REAL VALUES