Principles of Macroeconomics / Unit 3 MAC 0217 worked example, 60 to 90 seconds
Nominal to Real
The idea
To convert a nominal figure to a real one, divide by the price index for that year. When the index is stated around one hundred, divide the index by one hundred first, then divide the nominal figure by that. The result is expressed in the prices of the base year. Two consequences follow. In the base year the two figures are equal. After the base year, with prices higher, the real figure is smaller than the nominal one; before the base year, with prices lower, it is larger.
In practice
Worked example: nominal GDP is twenty-two trillion and the deflator is one hundred and ten, with a base year of twenty twenty. Divide one hundred and ten by one hundred to get one point one. Twenty-two trillion divided by one point one is twenty trillion, measured in twenty twenty prices. In the base year itself the deflator was one hundred, so real and nominal GDP were both whatever nominal GDP was that year.
Where people slip
Divide, never subtract. Taking the inflation rate off the nominal figure is an approximation that works for small changes and drifts badly for large ones. And the real figure means nothing without naming its base year, since the same output measured against different base years gives different numbers.
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Builds on
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