 Home » National Income and its Measurements  » Measurement of Gross Domestic Product in Current Price and Constant Price

# Measurement of Gross Domestic Product (GDP) in Current Price and Constant Price or Difference Between Nominal GDP and Real GDP:

## Definition and Explanation of Nominal GDP:

The gross domestic product (GDP) is the total market value of all the final goods and services produced within an economy in a given year. When all the components of GDP are valued a their current prices in the market, it is called nominal gross domestic product. Nominal GDP measures national income ruling at the time and thus takes no account of inflation.

In many applications of macro economics, the nominal GDP is not considered a measure of growth and welfare. Why this is so is explained by taking a simple example of two good economy and two years.

### Example:

Let us assume that an economy produces 100 pens and 50 books in the year 2001. The , price of one pen is \$1 and that of the book is \$2 in the market. The total value of the goods produced is \$200 in the year 2001 .

(100 pens x \$1 per pen) + (50 books x \$2 per book)

(100)        +     (100)     =     \$200

Suppose that in the year 2002, the production of the two goods, pens and books remains the same, but their prices get doubled. The total value of the goods then would be \$400.

(100 pens x \$2) + (50 books x \$4)

200        +     200    = \$400

The nominal GDP in the year 2001 is \$200 and is \$400 in the year 2002. The nominal GDP has increased by 100% even though the physical production of goods has remained the same. So, if we use the nominal GDP to measure growth of the economy, we will be misled into thinking that production has grown. What all has really happened is a rise in the price level. The standard of living of the people will increase only if (i) the economy produces larger quantity of goods than the previous year and (ii) the goods are sold at normal prices in the market.

The economists while studying the changes in the economy need a measure of output which shows an actual increase in production of goods and it is not affected by changes in their prices. To get this problem solved, the economist use a measure called Real GDP.

## Definition and Explanation of Real GDP:

Real gross, domestic product (Real GDP) is the production of goods and services valued at constant prices. It is also defined as GDP adjusted for price changes. It is a measure of output that reflects actual income in. production, separate and part from any price changes that may have occurred in the economy during the year.

### Example For Calculating Nominal GDP and Real GDP:

Let us take a simple example of a two good economy and of two years to explain the concept of Real GDP. The table given below shows the nominal GDP for two years 2001 and 2002.

Price and Quantity

 Year Price of Pen (\$) Quantity Produced (Pens) Price of Book (\$) Quantity Produced (books) 2001 1 100 2 50 2002 2 150 3 100

### Calculating Nominal GDP:

 2001 (\$1 per pen x 100 pens) + (\$2 per book x 50 books) = \$200 2002 (\$2 per pen x 150 pens) + (\$3 per book x 100 books) = \$600

### Calculating Real GDP:

 2001 (\$1 per pen x 100 pens) + (\$2 per book x 50 books) = \$200 2002 (\$1 per pen x 150 pens) + (\$2 per book x 100 books) = \$350

We find that real GDP has increased from \$200 in the year 2001 to \$350 in the year 2002. This increase is due to increase in quantities of goods produced because the prices are held fixed at base year levels. The real GDP enables us to see how much real income has changed from one year to another.

### Measuring Price Changes Overtime:

We can measure the changes in prices of goods overtime by an index called GDP Deflator.

### Definition of GDP Deflator:

GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.

### Formula For GDP Deflator:

GDP Deflator = Nominal GDP x 100

Real GDP         1

### Calculating the GDP Deflator:

 2001 \$200/\$200 x 100 = 100 2002 \$600/\$350 x 100 = 171

For the year 2002, the value of GDP deflator as worked out is \$171 and was 100 in the base year. This means that the price level has increased by 71% from the base year.

Base Year:

The year from which a financial or economic index is first calculated. It is normally set at an arbitrary level of 100. Any year can be chosen as a base year, but it is generally desirable to use a fairly recent one. New, more up to date base years are periodically introduced. An average value for a number of years can also be used as a base year.

## Relevant Articles:

 » Macro Economics and its Importance » Concepts of National Income » Methods of Computing/Measuring National Income » Circular Flow of National Income in a Two Sector Economy » Difficulties/Problems in the Measurement of National Income » Determinants of National Income or Factors Affecting the National Income » Gross Domestic Product as a Measure of Welfare/Growth/Development » Measurement of Gross Domestic Product in Current Price and Constant Price

 Principles and Theories of Micro Economics Definition and Explanation of Economics Theory of Consumer Behavior Indifference Curve Analysis of Consumer's Equilibrium Theory of Demand Theory of Supply Elasticity of Demand Elasticity of Supply Equilibrium of Demand and Supply Economic Resources Scale of Production Laws of Returns Production Function Cost Analysis Various Revenue Concepts Price and output Determination Under Perfect Competition Price and Output Determination Under Monopoly Price and Output Determination Under Monopolistic/Imperfect Competition Theory of Factor Pricing OR Theory of Distribution Rent Wages Interest Profits
 Principles and Theories of Macro Economics National Income and Its Measurement Principles of Public Finance Public Revenue and Taxation National Debt and Income Determination Fiscal Policy Determinants of the Level of National Income and Employment Determination of National Income Theories of Employment Theory of International Trade Balance of Payments Commercial Policy
 Development and Planning Economics Introduction to Development Economics Features of Developing Countries Economic Development and Economic Growth Theories of Under Development Theories of Economic Growth Agriculture and Economic Development Monetary Economics and Public Finance History of Money