What is the Nominal GDP?
Definition: Nominal GDP (Gross Domestic Product) denotes the value of all goods and services produced in a year in a country. The financial measure is calculated using current market prices and expressed in monetary terms. The financial metric acts as an assessment of the economic production of an economy as it focuses on the current prices of goods and services produced.
Nominal GDP factors in price changes that take place in a given accounting period. For instance, if prices of goods and services were to change from one period to another, nominal GDP would change, even if the output remained the same.
Real Gross Domestic Product differs from nominal GDP on the fact that it measures the value of all goods and services produced without taking into account changes in prices. Real GDP is calculated using the prices of a selected year rather than prevailing market prices.
Effects of Inflation on Nominal GDP
One of the factors that influence the final value of nominal GDP is inflation or deflation. The fact that the economic metric is measured using current prices is one of the reasons it keeps on changing in response to changes in prices of goods and services.
Inflation results in an increase in prices of goods and services. Likewise, the nominal GDP will tick higher whenever inflation increases, even with the amount of goods and service produced remaining the same. Similarly, nominal GDP would decrease with a decrease in the prices of goods and services in a given year.
Nominal GDP Formula Calculation
Three methods are used in the calculation of nominal GDP; they include income, production, and expenditure. In the expenditure model, all incomes are summed up, taking into consideration wages rent, interest, and profits earned by businesses and households in an economy.
The production method on its part is computed by subtracting net consumption from the estimated output in a year. The expenditure method, on the other hand, sums up the value of goods and services purchased in a country, in a given year, taking into consideration prevailing market prices.
Nominal GDP Examples
Consider Company XYZ that produces two sets of smartphones. The prices of the two phones fluctuated from year one to year three.
| Nominal GDP | ||||
| Year | Price | Number of Phones Sold | Price | Number of phones sold |
| 1 | $200 | 30 | $300 | 90 |
| 2 | $300 | 40 | $400 | 80 |
| 3 | $400 | 50 | $500 | 70 |
The nominal GDP for each year in this case will be
- Year 1: ($200 x 30) + ($300 x 90) = $33,000
- Year 2: ($300 x 40) + ($400 x 80) = $44,000
- Year 3: ($400 x 50) + ($500 x 70) = $55,000
The Real GDP for each year using price for the first year as the base price would be
- Year 1: ($200 x 30) + ($300 x 90) = $33,000
- Year 2: ($200 x 40) + ($300 x 80) = $32,000
- Year 3: ($200 x 50) + ($300 x 70) = $31,000
Nominal GDP is not the best for establishing the amount of growth that might have occurred in a given period. In most cases, it tends to overstate what happened, especially in periods where prices of goods and services fluctuate significantly.
For this reason, economists rely on Real GDP to ascertain the amount of growth that might have occurred. Real GDP relies on the use of prices from a base year.
Nominal GDP also does not provide an accurate representation of what is happening in an economy, especially in economies mired in recession. During a recession, prices of items tend to drop significantly. Likewise, nominal GDP could drop significantly, even on production remaining the same or ticking higher.
Summary
Nominal Gross Domestic Product is simply the value of all goods and services produced in a country in a single year. The economic measure relies on current market prices rather than a predetermined base price.