What Is The Difference Between Real And Nominal Gross Domestic Product?


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Tariq Habib answered
Gross domestic product is the dollar value of goods and services. In measuring the dollar value, we use the measuring rod of market prices for different good and services. But price change over time, as inflation generally sends prices upward year after year. Who would want to measure things with a rubber yardstick, one that stretches in your hands from day to day rather than a rigid and invariant yardstick?

The problem of changing prices is on of the problems economists have to solve when they use money as their measuring rod. Clearly, we want a measure of the nation's output and income that uses an invariant yardstick. Economists can replace the elastic yardstick with a reliable one by removing the price increase component so as to create a real or quantity index of national output.

The basic idea is the following: We can measure the gross domestic product for a particular year using the actual market prices of that year, this gives us the nominal gross domestic product, or gross domestic product at current prices. But we are usually more interested in determining what has happened to the real gross domestic product, which is an index of the volume or quantity of goods and services produced. More precise, we measure real gross domestic product by multiplying the quantities of goods by an invariant or fixed set of prices. Hence nominal gross domestic product is calculated using changing prices while real gross domestic product is calculated using constant prices.

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