Welcome to your study space
Understand economics at your own pace: step-by-step guided courses, and exercises to practice.
Nominal vs real GDP
Telling a rise in prices apart from genuine growth.
Real GDP = nominal GDP / deflator × 100Problem / motivation
GDP climbed 5% this year. Great… but did we actually produce more, or does everything simply cost more?
Until you separate the price effect from the quantity effect, a GDP figure can fool you. That is what the nominal / real distinction is for.
Two words before we go on. GDP — the value of everything newly produced in the country over a period (the subject of the course “GDP”) — is first measured at today's prices: that is NOMINAL GDP, also called GDP “in value” or “in current euros”. Count that same output again while neutralising the rise in prices and you get REAL GDP, called GDP “in volume” or “in constant euros”. This whole course is about getting from the first to the second.
Assumptions
In your view, which assumptions are needed for this model to hold? Jot down your ideas — no lead is wrong, this is your worksheet.
Your worksheet is still empty. Go for it: propose at least one idea.
0 idea(s) proposedFormalization
First, learn to read the tool. A price index is a thermometer whose zero is chosen: we set the price level of the base year at 100; if it reads 101, prices have risen by 1% since then; 95, they have fallen by 5%. Reading an index means reading a factor: 101 means “× 1.01”, just as “+4%” means “× 1.04”. The GDP deflator is that index, computed over the whole of output.
So where does the formula come from? Look at a one-good economy: a loaf cost €2 in the base year, it costs €2.02 this year (+1%). Nominal GDP counts this year's loaves at €2.02; real GDP counts those same loaves again at €2; the ratio of the two prices, 2.02 / 2 = 1.01, gives the deflator: 101. Dividing the nominal figure by 101 then multiplying by 100 therefore means dividing by 1.01: you cancel the rise in prices, nothing magical.
And the formula reads both ways: deflator = nominal GDP / real GDP × 100 — turn the fraction over and you get back real GDP = nominal GDP / deflator × 100. The exercises will have you handle it in both directions.
One last secret: in the national accounts, nobody “measures” the deflator. INSEE — France's national statistics institute — first computes GDP in volume (quantities, valued at base-year prices), and the deflator follows from it: it is the “nominal / real × 100” we have just written. The deflator an exam question hands you ready-made comes from there. Click each term:
Solving / calculation
Nominal GDP is 2,856 €bn (billions of euros, written “€bn”), the deflator 101. What is real output? Then move the values around.
- Start from nominal GDP
nominal GDP = 2,856 €bn - Read the index: 101, so prices are up 1% since the base year
deflator = 101 - Deflate — dividing by 101 then × 100 means dividing by 1.01
real GDP = 2,856 / 101 × 100real GDP ≈ 2,828 €bn - Gap due to prices
2,856 − 2,828≈ 28 €bn of price increases, not of output
Of the 2,856 €bn on display, ~28 reflect nothing but the rise in prices: what we are breaking down here is the nominal figure (so the gap reads in current euros, just like it). In volume, output is worth 2,828 €bn, counted at base-year prices — in constant euros.
real GDP = nominal GDP / deflator × 100Vary nominal GDP and the deflator: real GDP recomputes itself.
Economic interpretation
Real GDP is the only measure that lets you compare volumes over time. Inflation — the general rise in prices — erodes instead the value of every euro:
Only real GDP lets you say “we produce more than 10 years ago”: the nominal figure mixes output and prices together.
Strong nominal growth can hide real stagnation if prices are soaring.
Nominal growth ≈ real growth + inflation. The “≈” matters: +4% means × 1.04, and increases multiply — the second applies to an amount already increased: 1.04 × 1.05 = 1.092, that is +9.2%, not 9%. Deflating means dividing, never subtracting rates.
Nominal = “in value” = in current euros. Real = “in volume” = in constant euros. Textbooks and INSEE use either one interchangeably — it is the same concept.
Limits / critiques
Exercises
Nominal GDP = 4,200 €bn, deflator = 105. What is real GDP (in €bn, rounded)?
True or false: if the deflator is 100, nominal and real GDP are equal.
Base year: GDP = 2,500 €bn (deflator 100). One year later: nominal GDP = 2,730 €bn, deflator = 105. What is REAL growth (in %)? (Reminder: growth in % = gap / starting value × 100.)
Nominal GDP = 1,980 €bn, deflator = 99. Real GDP is…
Nominal GDP +6%, prices +6%. Real growth is…
Nominal GDP = 3,150 €bn, real GDP = 3,000 €bn. What is the deflator (the index)?
Nominal growth is 10.25% and prices have risen by 5%. Real growth is…
A small two-good economy. At base-year prices: a loaf is worth €1, a bicycle €200. This year, 100 loaves are produced (sold at €1.30 each) and 2 bicycles (sold at €210 each). What is the deflator?