Updated July 29, 2023
Definition of Nominal GDP
Nominal GDP is the sum spent on goods and services produced during a specific period in the country. It is one of the most important macroeconomic parameters to gauge the country’s output level.
The total value of an economy’s goods and services at current market prices. There are various approaches to calculating nominal GDP, which we will discuss in greater detail later.
Though the approaches are different, the final output for all will not differ. As the nominal Gross Domestic Product is based on the current price, inflation will increase nominal GDP even if the physical output of goods and services remains constant from one year to the next. That’s why to get a real sense of how much is the real output of goods and services, economists use various techniques to adjust the nominal GDP figure and come up with other measures. Some of those measures are real GDP, producer price index, and consumer price index.
How to Calculate the Nominal GDP?
Nominal GDP calculates as the sum of all the spending on newly-produced goods and services or the income received from producing these goods and services.
There are three approaches to calculating nominal Gross Domestic Product: expenditure, income, and production.
- Expenditure approach: The expenditure approach calculates GDP by summing the amounts spent on goods and services produced during the period. For example, suppose a paint manufacturer manufactures paints. It will not be included in the calculation of GDP if it is not produced in the period for which GDP is calculated.
- Income approach: All the earnings by individuals and companies are taken into account to calculate nominal GDP based on the income approach. These incomes include salaries, wages, income, and interest earned.
- Production approach: The production approach calculates GDP by actively calculating the total output and immediate consumption.
For an economy N different goods and services, it can be calculated as:
What are all Included and Excluded in the Calculation of Nominal GDP?
Economists widely use GDP as the most common measure of a nation’s economy size. Only the final goods’ market price is part of the nominal GDP calculation; any parts that go into producing a final product are not part of GDP. For example, the value of the computer chips that Intel makes is not included in the calculation of GDP; their value is included in the final prices of computers that use the chips. If a paint manufacturer manufactures paints, it is not included in calculating GDP if it is not produced in the period for which GDP is calculated.
The government-provided goods and services are part of the nominal Gross Domestic Product calculation. For example, the services provided by the police and the judiciary and goods such as roads and infrastructure improvements are included. The government values these goods and services at their own cost, even though they are not sold at market prices. The government’s transfer payments in the form of welfare schemes for the economically weak section of the population are not part of the GDP calculation as they do not create any economic output for the country.
Rental income from the property is part of the nominal GDP. Economists estimate the value of owner-occupied housing for inclusion in GDP because it is not revealed in market transactions. However, they do not include the value of labor not sold, such as homeowners’ repairs to their own homes, in GDP. Additionally, GDP does not incorporate by-products of production, such as environmental damage.
Effect of Inflation and How to Deal with it?
It includes the effect of inflation. The effect of inflation in the nominal GDP inflates the actual output with inflation in the economy, and the purchasing power of individuals decreases. The same thing with the same nature and output quantity will have the total value, which is higher just because of inflation.
Despite the same level of output and production in the economy in a particular period, just due to inflation, the total nominal GDP amount looks inflated. The economist adjusts the nominal GDP better to estimate the actual production of goods and services. Adjusting the nominal Gross Domestic Product enables the derivation of various measures such as the consumer price index, producer price index, and real GDP. This adjustment helps get a fair assumption of the real output in an economy. Several measures, like a GDP deflator, help convert a nominal GDP into real GDP.
Conclusion
It is one of the most important macroeconomic parameters to measure the level of the output of goods and services in the country for a specific period of time. It includes the effect of inflation, and nominal GDP calculates with three approaches: the expenditure approach, the income approach, and production. Though the approaches are different, the three approaches’ output will provide the same result. Since the nominal Gross Domestic Product includes the effect of price rise in its calculation, it sometimes becomes difficult to determine the actual output level. That’s why economists also use a different GDP form real GDP and techniques like GDP deflator to arrive at it.
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