Explaining the Difference between Nominal and Real National Income (GDP)

It is important to distinguish between the nominal and real value of a country's national output and income.

Nominal GDP measures the value of all final goods and services produced in a country in a given year, using the prices of that year. Real GDP measures the value of all final goods and services produced in a country in a given year, using the prices of a base year.

The difference between nominal and real GDP can be calculated using the following formula:

Real GDP = Nominal GDP / GDP Deflator

The GDP deflator is a measure of the prices of all final goods and services produced in a country in a given year, relative to the prices of a base year.

For example, let's say that the nominal GDP of the United Kingdom in 2022 was £2 trillion, and the GDP deflator was 120. This means that the prices of all final goods and services produced in the United Kingdom in 2022 were 20% higher than the prices in the base year of 2020.

The real GDP of the United Kingdom in 2022 would be calculated as follows:

Real GDP = Nominal GDP / GDP Deflator = £2 trillion / 1.2 = £1.67 trillion

This means that the real value of all final goods and services produced in the United Kingdom in 2022 was £1.67 trillion, which is 20% lower than the nominal value of £2 trillion.

Nominal GDP is often used as a measure of economic growth, as it shows the total value of goods and services produced in a country in a given year. However, real GDP is a better measure of economic growth, as it shows the change in the actual value of goods and services produced in a country, after taking inflation into account.