Gross National Product: Nominal GNP and Real GNP

Nominal GNP and Real GNP Nominal GNP is the market value of a nation's aggregate production of final output based on current prices for the goods and services produced during the year. Nominal GNP is of only limited use in measuring changes in aggregate production over time. This is because nominal GNP can rise from one year to the next as a result of increases in the market prices of goods even when the nation's aggregate production of final products does not increase. In fact, nominal GNP can increase as a result of substantial increases in a broad array of market prices even when the nation's aggregate production of final output actually declines! Similarly, if market prices were to fall substantially during a year, nominal GNP might fall even if the nation's aggregate production goes up. Real GNP is a measure of the value of a nation's aggregate output of final products obtained by using market prices prevailing for products during a certain base or reference year. Real GNP indicates the expenditure in dollars necessary to buy the economy's final products during a given year if they were sold at prices prevailing in the base year. The base year for U.S. real GNP was 1982 from 1986-1991. Beginning in 1992, the year 1987 will be used as the base. Calculation of real GNP allows more accurate measurement of changes in aggregate production in the economy over time by adjusting nominal GNP for the effects of inflation. Calculating Nominal and Real GNP: A Simple Example A simple numerical example will make clear the distinction between nominal and real GNP. Imagine an economy where only two final products are produced each year: pizzas and jeans. Suppose that in 1982 the economy's final products were 2 million pizzas and 1 million pairs of jeans. The market price of a pizza in 1982 is $5, and the market price of a pair of jeans is $20. The market value of pizzas that year is therefore $10 million, while the market value of jeans amounts to $20 million. Nominal GNP is the sum of the market values of pizzas and jeans, which in this case is $30 million. The $30 million sum represents the market value of the economy's aggregate production using current prices prevailing during the year. Nominal GNP in the United States is calculated in a similar fashion by estimating the production of each industry and then multiplying units of production by current market prices and summing the market values of all the many products. The table in Box 2 shows how both nominal and real GNP can be computed for this imaginary economy for different years. Notice that, in calculating nominal GNP in 1990, the output of both pizzas and jeans is significantly greater than it was in 1982. As you can see, production of both these goods has doubled over the 8-year period. Also note that the 1990 market prices of the two goods have increased from their 1982 levels. As the calculation in the table shows, based on the $6 market price prevailing in 1990, the market value of the 4 million pizzas produced that year is $24 million. Similarly, the market value of the 2 million pairs of jeans produced in 1990 is $50 million based on the price of $25 per pair prevailing that year. The market value of the economy's aggregate production of final products is therefore $74 million based on 1990 market prices. If you now compare nominal GNP between 1982 and 1990, you can see why nominal GNP gives a misleading picture of the change in aggregate production between the two years. The output of each of the two products in the economy has doubled from 1982 to 1990; however, between 1982 and 1990 nominal GNP has more than doubled (from $30 million to $74 million). The discrepancy between growth in output and growth in nominal GNP stems from the fact that the growth in nominal GNP represents an amalgam of the changes in the prices of the products and the growth in output. It's easy to obtain an accurate estimate of the change in aggregate production by valuing products produced in 1990 at the prices that prevailed in 1982. The market value of pizza in 1990 based on the $5 price that prevailed in 1982 is $20 million, while the market value of jeans produced in 1990 valued at the $20 price that prevailed in 1982 is $40 million. Summing these two market values gives a real GNP of $60 million, which is twice the real GNP that prevailed in 1982. The doubling of real GNP reflects the doubling of aggregate production. Note that 1982 nominal GNP is also 1982 real GNP when 1982 is used as the base year. Let's look at the changes in the values of real GNP and nominal GNP in the United States between 1981 and 1982. Nominal GNP in 1981 was equal to $3,052.6 billion. In 1982 nominal GNP went up to $3,166.0 billion. However, 1982 was a very bad year for the economy because the nation's aggregate production actually declined from the level prevailing in 1981. When aggregate production of the economy for both 1981 and 1982 was valued at prices prevailing in 1982, real GNP fell from $3,248.8 billion in 1981 to $3,166.0 billion in 1982. The decline in real GNP in 1982 caused considerable disruption in the operation of the economy as unemployment increased and household incomes declined because of the cutback in production that year. The graph in Box 3 charts both real GNP and nominal GNP for the economy from 1970 to 1990. Note that nominal GNP increases at a more rapid rate over time than does real GNP. Nominal GNP has grown more quickly than real GNP since 1970 because prices have risen on average since that time. Also note that real GNP is more apt to decline than is nominal GNP. The graph shows sharp declines in real GNP during the periods 1973-1975 and 1981-1982.