Principles of Macroeconomics / Unit 18 MAC 1719 worked example, 60 to 90 seconds
Deflating a Series
The idea
Convert a nominal figure to real terms, then compute a growth rate that means something. Divide the nominal figure by the price index for its year and multiply by a hundred. Do it for both years before comparing them, and never compare a real figure with a nominal one.
In practice
An economy produces 20,000 in year one, when the price index is 100, and 26,000 in year two, when the index is 125. Year one's real output is 20,000 divided by 100 times 100, which is 20,000. Year two's real output is 26,000 divided by 125 times 100, which is 20,800. So nominal output rose 30 percent while real output rose 4 percent. The remaining 26 percentage points were prices, not goods.
Where people slip
The gap between 30 and 4 is the whole reason the distinction exists. A question reporting that output rose 30 percent while prices rose 25 percent is not describing a boom; it is describing an economy that grew about 4 percent. Any figure in money terms across two years needs this done before it can be read.
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