Nominal vs. Real GDP

"Are you better off today than you were 4 years ago? What about 40 years ago?"

These sorts of questions invite a different kind of query: what exactly do we mean, when we say “better off?” And more importantly, how do we know if we’re better off or not?

To those questions, there’s one figure that can shed at least a partial light: real GDP.

In the previous video, you learned about how to compute GDP. But what you learned to compute was a very particular kind: the nominal GDP, which isn’t adjusted for inflation, and doesn’t account for increases in the population.

A lack of these controls produces a kind of mirage.

For example, compare the US nominal GDP in 1950. It was roughly $320 billion. Pretty good, right? Now compare that with 2015’s nominal GDP: over $17 trillion.

That’s 55 times bigger than in 1950!

But wait. Prices have also increased since 1950. A loaf of bread, which used to cost a dime, now costs a couple dollars. Think back to how GDP is computed. Do you see how price increases impact GDP?

When prices go up, nominal GDP might go up, even if there hasn’t been any real growth in the production of goods and services. Not to mention, the US population has also increased since 1950.

As we said before: without proper controls in place, even if you know how to compute for nominal GDP, all you get is a mirage.

So, how do you calculate real GDP? That’s what you’ll learn today.

In this video, we’ll walk you through the factors that go into the computation of real GDP.

We’ll show you how to distinguish between nominal GDP, which can balloon via rising prices, and real GDP—a figure built on the production of either more goods and services, or more valuable kinds of them. This way, you’ll learn to distinguish between inflation-driven GDP, and improvement-driven GDP.

Oh, and we’ll also show you a handy little tool named FRED — the Federal Reserve Economic Data website.

FRED will help you study how real GDP has changed over the years. It’ll show you what it looks like during healthy times, and during recessions. FRED will help you answer the question, “If prices hadn’t changed, how much would GDP truly have increased?”

FRED will also show you how to account for population, by helping you compute a key figure: real GDP per capita. Once you learn all this, not only will you see past the the nominal GDP-mirage, but you’ll also get an idea of how to answer our central question:

"Are we better off than we were all those years ago?"

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- [Alex] Is the economy growing?

Are people better off today
than they were four years ago?

What about 40 years ago?

The GDP statistic can help us to answer
all of these questions.

But first, we do need
to make some modifications.

As we discussed in our first video,

GDP sums up the prices
of all finished goods and services.

So that means that there are two ways
the GDP can increase.

First, prices can increase.

In this case, the GDP number goes up,

but the economy isn't actually producing
more goods and services.

It's inflation which is driving
the higher GDP.

The increase in GDP --
it might look good on paper --

but it's a mirage,
a nominal increase only.

The other way that GDP can increase

is if we DO produce
more valuable goods and services.

That could mean simply
more goods and services,

or better goods and services,

more highly-valued goods and services.

It's this second type
of increase in GDP that we want.

This isn't a mirage,
this is a real increase in GDP.

Real GDP measures
the second type of growth.

And the Real GDP statistic --
it controls for inflation

by adding up all the goods
and services produced in an economy

using the same set of prices over time.

The same set of prices.

Real GDP tells us -- if, if the prices
of goods and services hadn't changed,

how much would GDP
have increased, or decreased?

Real GDP -- it's typically
what we really care about.

Let's give an example.

We'll be using a fantastic tool

called the St. Louis Federal Reserve
Economic Database, or FRED.

FRED is every economist's best friend.

So let's Google "US nominal GDP Fred."

Here's what we get.

We can see that we've grown
from a GDP in 1950 of $320 billion,

to a GDP in 2015 of over $17 trillion.

Wow! That suggests that our economy
has gotten 55 times bigger.

But hold on, hold on,
wait a moment, you might say.

My grandmother told me
that a loaf of bread used to cost a dime.

And now it costs a couple of dollars.

That's right.

If we want to compare
our economy over time,

we need to control
for changes in prices.

So we don't want to look at Nominal GDP.

We're more interested in Real GDP.

So let's Google "Real US GDP Fred."

Here's what we get.

This graph measures
Real GDP in 2009 dollars.

That means using 2009 prices.

This graph tells us
that using 2009 prices consistently,

that in 1950, all the goods and services
produced at that time

were worth about $2 trillion.

In comparison, in 2015,

all the goods and services
produced at that time

were worth about $16 trillion.

So while Nominal GDP says that the economy
is 55 times bigger in 2015 than in 1950,

Real GDP shows us
that it's 8 times bigger.

That's still pretty good,
but a big difference

between Nominal GDP and Real GDP.

Okay. So now we've controlled for prices,
but there's another big difference

in the US economy in 1950
compared to today.

Right - there's a lot more people today.

We can control for the population size

by using Real GDP
per capita, or per person.

By dividing Real GDP
by a country's population,

we get a good, albeit imperfect,

measure of the average
standard of living in a county.

So once again, let's Google,
"Real GDP per capita FRED."

Here's what we get.

In 1950,

Real GDP per capita,
measured in constant prices,

was about $14,000.

In 2015, Real GDP per capita
is about $50,000.

So on average, people in 2015
have a standard of living

that's four times higher
than the people in 1950.

That's a pretty big and a remarkable
increase in the standard of living.

By the way, since Real GDP
increased by eight times,

and Real GDP per capita
increased by four times,

we know immediately

that the population approximately doubled
between 1950 and 2015.

Now let's take a closer look
at this graph.

We can see another reason
why we're interested in the GDP statistic.

Real GDP per capita
declines during recessions.

In fact, a decline in Real GDP
is part of what defines a recession.

Declines in Real GDP

also tend to be accompanied
by increases in unemployment.

You can see here that when Real GDP dips,
the unemployment rate spikes.

Now here's another nice feature
of the FRED database.

On the Real GDP per capita graph,
click "Edit data series"

and then switch to percent annual changes.

So now we can see immediately
the annual changes in Real GDP.

You can see, for example,
the big recession in 2008 and 2009.

In 2009, for example,
the economy shrank by 3.6%

compared to the year before.

That's a very big
and a very unpleasant decline.

Okay. So now you've got
your hands around Real GDP

as a way of measuring
the health of our economy.

And I said that Real GDP per capita
is a good, albeit imperfect measure

of the average standard
of living in a country.

But is that really true?

Does an increase in Real GDP per capita
mean that we're better off?

That's the view that I'm going
to defend in the next video.

- [Narrator] If you want to test yourself,
click "Practice Questions."

Or, if you're ready to move on,
you can click "Go to the next video."

You can also visit MRUniversity.com

to see our entire library
of videos and resources.

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