What is Nominal GDP?
Nominal GDP is the sum of amounts 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 level of output. The total value of all goods and services produced by an economy is valued at current market prices. There are various approaches to calculate nominal GDP, which we will discuss in greater detail later.
Though the approaches are different, the final output for all the approaches will not be different. As the nominal Gross Domestic Product is based on current price, inflation will increase nominal GDP even if the physical output of goods and services remains constant from one year to the next year. 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 can be calculated as the sum of all the spending on newly-produced goods and services or the sum of the income received due to producing these goods and services.
There are three approaches to calculate nominal Gross Domestic Product: the expenditure approach, the income approach, and the production approach.
- Expenditure approach: Under the expenditure approach, GDP is calculated 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: Under the production approach, it is calculated by 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?
GDP is the most widely used measure of the size of a nation’s economy. Only the final goods’ market price is part of nominal GDP calculation; any parts that go into the production of 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.
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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. As these goods and services are not sold at market prices, they are valued at their government’s cost. 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 nominal GDP. As the value of owner-occupied housing is not revealed in market transactions, the value is estimated for inclusion in GDP. The value of labor not sold, such as homeowner’s repairs to his own home, is not included in GDP. Also, By-products of production, such as environmental damage are also not included in GDP.
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, 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. To get a better estimate of the actual production of goods and services, the economist adjusts the nominal GDP. With the adjustment of nominal Gross Domestic Product varies, other measures are arrived at like consumer price index, producer price index, and real GDP. This adjustment helps in getting a fair assumption of the real output in an economy. There are several measures like GDP deflator, which helps convert a nominal GDP into real GDP.
Conclusion
Nominal GDP 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 can be calculated 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 use techniques like GDP deflator to arrive at it.
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