The distinction between nominal and real GDP (16 marks)
In macroeconomics, the distinction between nominal and real GDP is a threshold concept and is crucial in analysing economic data.
Nominal GDP (current-price GDP) is the actual value of GDP and so captures the monetary value of the economy’s output. It is affected over time by both changes in prices and in the volume of what is produced. So, for example, nominal GDP in 2017 would be the value of a country’s output at 2017 prices. The same principle applies to other years. Hence, no account is made for the effect of inflation, rather the effect of inflation is incorporated within these figures. In 2017 the nominal (or actual) value of GDP in the UK rose above £2 trillion. It had risen above the £1 trillion-mark back in 1999. If we are to make a sensible comparison of national income in these two years, we must take inflation into account. If the doubling of national income was merely the result of a doubling in the general price level for goods and services, then there would be no real increase in national income.
However, it we want to isolate changes in volume of the country’s output, we need to analyse real GDP. Real GDP (constant-price GDP) suggests that over time changes in real GDP capture only inferred changes in the volume output. Real GDP figures measure GDP in the prices that ruled in a year; the base year. This would enable us to see how much real GDP had changed from one period to another by eliminating increases (or decreases) in nominal GDP due to increases (or decreases) in prices. As a result, real GDP figures allow inferences to be drawn about the percentage change in the volume of production over time, such as those from one year to next. Therefore, the growth in real GDP is used by economists in measuring economic growth and is reflected in an economy’s business cycle. Similarly, the latest headline growth numbers reported by the likes of the Office for National Statistics here in the...