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 cell phones. The country bakes 200 pizzas at $10 each in year 1. In that same year, it manufactures 100 cell phones at $50 each.
In year 2, the country makes 190 pizzas and 110 cell phones at respective prices of $12 and $60 each. Using 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:

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.

The Fisher Formula

Recently, our 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: BEA (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.

United States Nominal and Real GDP Throughout the Years

The table below shows United States Bureau of Economic Analyis selected annual nominal and real GDP data for the United States from 1930 through 2011, in chained year 2005 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 recession, real GDP fell from 2008 to 2009, but grew again after 2009.

Source: www.bea.gov.