Sample Real GDP Calculation Econ 102-1 Alley Nominal GDP is calculated by summing the value of goods and

services produced in a given year using the prices of these outputs in that year. If the general price level increases or decreases from one year to the next, it is difficult to compare the amount of output that a country produces across different years. To correct for this, we want to value output in every year using the same prices. In other words, we calculate real GDP. Consider the following example: Nominal GDP for each of three years is as follows: 2001: $10 trillion 1996: $7.813 trillion 1968: $1 trillion In order to calculate real GDP for each year, we need to first pick a base year. We will use 1996. For each year (except the base year), we calculate a GDP deflator, which is a number, that, when divided into nominal GDP and multiplied by 100, yields the real GDP for that year. Precisely,
realGDP = nomGDP * 100 GDPdeflator

The GDP deflator is calculated by the following technique: 1. Construct a basket of goods. This basket represents things that an average family purchases in a year. For our example, we will not specify the make-up of this basket, but assert that it exists. 2. Value this basket of goods in each year using prices in each year. For example, assume that the basket is valued in each year as follows: 2001: $1,085,100 1996: $1,000,000 1968: $260,000 3. Calculate the deflator for each year (except the base year) using the following equations: GDP deflator(2001) = [(value of basket 2001)/( value of basket base year)]*100 = [($1,085,100)/($1,000,000)] * 100 = 108.51 GDP deflator(1968) = [(value of basket 1968)/( value of basket base year)]*100 = [($260,000)/($1,000,000)]*100 = 26

We can now calculate real GDP for every year in 1996 dollars. Note that real GDP for the base year is equal to the nominal GDP for that year. Real GDP 1996 = $7.813 trillion Real GDP 2001 = ($10 trillion/108.51)*100 = $9.216 trillion Real GDP 1968 = ($1 trillion/26)*100 = $3.846 trillion To see why it is important to compare output in different years using real GDP rather than nominal GDP, consider the GDP growth rate between 1996 and 2001. The growth rate of nominal GDP = [($10 trillion - $1 trillion)/ $1 trillion]*100% = 900% The growth rate of real GDP = [($9.216 trillion - $3.846 trillion)/ $3.846 trillion]*100% = 140%