What it means
The calculation is conceptually simple: multiply everything produced by the price it sold for, and add it all up. Statisticians do this using expenditure, income or output approaches that should in principle give the same answer, and the headline figure is published quarterly.
The reason nominal GDP matters to a business is that it is measured in the same currency as your own revenue. Comparing your sales growth to nominal GDP growth tells you whether you are gaining or losing ground in the actual economy your customers live in, whereas comparing to real GDP mixes measures.
It is also the natural denominator for a great many ratios that get quoted in the news. Government debt to GDP, tax revenue as a share of GDP and deficit ratios are all calculated against nominal GDP, because the numerators are themselves cash amounts at current prices.
The weakness is obvious once stated. In a year with 9% inflation and no extra output at all, nominal GDP grows 9% and a headline could reasonably announce record economic output while the country produced exactly the same number of goods as the year before.
The bridge between the two measures is the GDP deflator, an index of the overall price level. Divide nominal GDP by the deflator and multiply by 100 to get real GDP, which is the figure economists use when they want to talk about genuine growth.
In practice
Real-world examples.
Example
A logistics company reports 8% revenue growth in a year when nominal GDP grew 9%. Management concludes it lost a little market share in cash terms, a conclusion it could not have drawn by comparing against real GDP growth of 3%.
Example
A finance ministry announces that government debt has fallen from 92% to 88% of GDP. Most of the improvement comes from nominal GDP rising with inflation rather than from any reduction in the amount owed.
Example
An investor comparing two emerging markets sees nominal GDP growth of 14% in one and 6% in the other. Adjusting for inflation of 11% and 2% shows real growth of roughly 3% and 4%, reversing the apparent ranking.
Think of it
“Nominal GDP is output at today's prices-including both growth and inflation.
Formula
Calculation
Nominal GDP = sum of (quantity produced x current price) for all final goods and services. Real GDP = nominal GDP / GDP deflator x 100
Take a deliberately tiny economy producing three things in year one: 200,000 loaves of bread at $3, 5,000 bicycles at $400 and 10,000 haircuts at $40. That gives $600,000 + $2,000,000 + $400,000 = $3,000,000 of nominal GDP.
In year two, every quantity rises 5% and every price rises 10%. Nominal GDP becomes $3,000,000 x 1.05 x 1.10 = $3,465,000, a headline growth rate of 15.5%. With a GDP deflator of 110, real GDP is $3,465,000 / 110 x 100 = $3,150,000, which is exactly 5% above the previous year, so the honest measure of extra output produced is 5% and the other 10.5 percentage points of the headline came from prices.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Redlands Packaging, an invented supplier of corrugated boxes, set its annual sales targets at "GDP growth plus three percentage points" without specifying which GDP measure it meant. For years inflation was low and nobody noticed the ambiguity.
In this fictional scenario a year of 8% inflation arrived. The commercial team argued the target should be nominal GDP growth of 10% plus three, giving 13%, while the finance director had budgeted against real growth of 2% plus three, giving 5%. The gap between the two readings of the same sentence was worth about $19,000,000 of revenue on a $240,000,000 base.
The invented company resolved it by fixing on nominal GDP for revenue targets, on the grounds that the sales team sells at current prices and is paid in current dollars, while using real GDP for volume and capacity planning. Redlands also rewrote its bonus scheme so that hitting a purely inflation driven revenue number no longer counted as outperformance.
Watch out
Common mistakes.
- Reading strong nominal GDP growth as strong economic performance without checking inflation, when a large part of the increase may be prices rather than output.
- Comparing a company's real volume growth against nominal GDP growth, which mixes an inflation-adjusted figure with one that is not and produces a meaningless gap.
- Comparing nominal GDP across countries using current exchange rates alone, which ignores differences in what money actually buys in each place.
Questions
People also ask.
Which measure should a business plan against?
Use nominal GDP for revenue and pricing because your invoices are in current prices, and real GDP for volumes, capacity and headcount.
What is the GDP deflator?
It is a broad index of the price level across everything an economy produces, used to convert nominal GDP into real GDP.
Can nominal GDP rise while the economy shrinks?
Yes, if prices rise faster than output falls, which is exactly what happens in a stagflationary period.
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