Question

Contrast nominal GDP and real GDP. Why is one more reliable than the other for comparing changes in the standard of living over a series of years? What is the GDP price index, and what is its role in differentiating nominal GDP and real GDP?

Short answer

Nominal GDP refers to the overall market value of the goods and services produced in an economy during a particular period, while real GDP refers to the nominal GDP adjusted to inflation.

Real GDP uses constant price, and it is more accurate than the nominal GDP. So real GDP is a more reliable measure to understand changes.

The GDP price index is the measure of the price of a collection of specific goods and services in the market. The real GDP can be obtained by dividing nominal GDP by price index.

Step-by-step solution

Nominal and real GDP

Nominal GDP accounts for the measure of each year’s output in terms of prices that are currently prevailing in the market.The nominal GDP is not adjusted with inflation. The real GDP measures the price of output concerning the current prices in the economy by selecting a particular year as the base year. This is because the real GDP is the price leveladjusted with inflation in the economy.

The real GDP is considered a more reliable measure for comparing changes. Because nominal GDP is the one that is not adjusted to the change in the price level, it is based on the current price level only. In contrast, the real GDP is the one that is adjusted to the changes in the price level.

GDP price index

The price index is the measure of inflation in the goods and services that are produced in the economy.The price index is a measure of the prices of goods in the market basket compared to the prices of goods in a reference year. Exported goods are also included in the price index.

The price index is calculated by dividing the nominal GDP by the real GDP. The real GDP can be obtained by dividing nominal GDP by the price index.