Nominal GDP values output at the prices of the year it was produced, so it rises when prices rise even if the economy makes nothing extra. Real GDP values every year's output at the same base-year prices, so it changes only when output changes. Edit the prices and quantities for a small economy, then follow each calculation step by step.
A small economy produces a few final goods over three years. Every number in the table is editable. The chart and the work update as you type.
The value of final goods and services at the prices of the year they were produced. It can rise because output rose, because prices rose, or both. Taken alone, a rise in nominal GDP does not tell you the economy made more.
The value of the same output at constant base-year prices. Prices are held fixed, so real GDP changes only when quantities change. That is why economists use real GDP to measure output and economic growth.
A price index for everything counted in GDP. It equals 100 in the base year, where nominal and real GDP are the same. A deflator of 125 means prices are 25% higher than in the base year. The percentage change in the deflator is a measure of inflation.
If you know nominal GDP and the deflator, divide to remove the price effect. Nominal GDP of $1,500 with a deflator of 120 is real GDP of $1,250 in base-year dollars.
The GDP deflator covers all final goods and services produced domestically, including investment goods and government purchases, and leaves out imports. The CPI tracks a fixed basket of goods bought by consumers, and that basket includes imports. A rise in the price of imported cars raises the CPI but not the deflator.
Real GDP per person is the usual measure of the average standard of living. If population grows faster than real GDP, real GDP per capita falls even though total output rose.
An economy produces pens and notebooks. The base year is Year 1. Cover the right-hand columns and work each row yourself, then check. This is the same problem as the "Two-good AP problem" scenario above.
| Year | Pens (P × Q) | Notebooks (P × Q) | Nominal GDP | Real GDP (Year 1 prices) | GDP deflator | Real GDP growth |
|---|---|---|---|---|---|---|
| 1 (base) | $1 × 200 | $4 × 50 | 200 + 200 = $400 | 1×200 + 4×50 = $400 | 400 ÷ 400 × 100 = 100 | none (first year) |
| 2 | $2 × 220 | $5 × 55 | 440 + 275 = $715 | 1×220 + 4×55 = $440 | 715 ÷ 440 × 100 = 162.5 | (440 − 400) ÷ 400 = +10.0% |
| 3 | $3 × 210 | $6 × 50 | 630 + 300 = $930 | 1×210 + 4×50 = $410 | 930 ÷ 410 × 100 = 226.8 | (410 − 440) ÷ 440 = −6.8% |
In Year 3, nominal GDP rose 30.1% while real GDP fell 6.8%. Output fell; higher prices hid the drop. Inflation from Year 2 to Year 3, measured by the deflator, was (226.8 − 162.5) ÷ 162.5 × 100 ≈ 39.6%.
| Question | GDP deflator | Consumer price index (CPI) |
|---|---|---|
| Which goods are covered? | All final goods and services produced domestically (C, I, G, and exports) | A fixed market basket bought by a typical urban household |
| Imports? | Not included (they are not produced domestically) | Included if consumers buy them |
| Capital goods and government purchases? | Included | Not included |
| How it is found | Nominal GDP ÷ real GDP × 100 | Cost of basket this year ÷ cost in base year × 100 |
| Base year value | 100 | 100 |
AP-style multiple choice. Pick an answer to see the explanation.
The vocabulary for topic 2.6. Read the list, flip through flashcards, or quiz yourself. For every term in the unit, see the Unit 2 terminology guide.