What is 'Nominal GDP'
Nominal GDP is gross domestic product (GDP) evaluated at current market prices, GDP being the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Nominal differs from real GDP in that it includes changes in prices due to inflation or a rise in the overall price level.
BREAKING DOWN 'Nominal GDP'
Nominal GDP can be measured by one of three ways: the expenditure, production or income approach. The expenditure approach adds up the market value of all domestic purchases of final goods and services in a single year. In the production approach, net production is determined by subtracting intermediate consumption from total estimated output. The income approach is the sum of all the income earned by firms and households in a single year, being all the income received in the form of wages, profit, interest and rent.
Effects of Inflation
A growing nominal GDP might reflect a rise in inflation as opposed to growth in the amount of goods and services produced.
Inflation is a negative force for economic participants because it diminishes the purchasing power of income and savings, both for consumers and investors.
When the overall price level of the economy rises, consumers have to spend more in order to purchase the same amount of goods. If an individual’s income rises by 10%, in a given time period, but inflation rises 10% as well, then that individual’s real income (purchasing power) is unchanged. Investors are averse to inflation because it eats into their return on investment. If they loan out $100 at a 7% interest rate for a given time period and inflation is 7% over that same period, their real rate of interest is zero.
Adjusting Nominal GDP
To extract real economic data from nominal GDP, without the distortion of inflation, an appropriate price index is needed. The most common prices indices are the Consumer Price Index (CPI), the Producer Price Index (PPI) and the GDP deflator.
CPI is a measure of the change in prices paid by urban residents for a market basket of consumer goods and services. This basket is broken up into the categories of food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and others goods and services, but it does not include any investment goods. The basket is measured in index points, so the rate of inflation can be calculated by dividing the change in index points by the CPI of the year you wish to measure inflation from. This value, in turn, is used to calculate real GDP growth from one year to another.