source: dnaindia.com
What is the Nominal GDP?
Nominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country’s population at current market price of goods and services generated by four main sources which include capital appreciation on Land, wages of Labor, interest on Capital investment and profits earned by an entrepreneur that is calculated only on finished goods and services.
How to Calculate the Nominal GDP?
Nominal GDP calculation is easy. Here’s why –
- Firstly, it is calculated on the basis of the market price of the current year. That means all the current market changes would be adjusted while calculation nominal GDP.
- Secondly, the nominal gross domestic product doesn’t take inflation into effect.
Calculating the nominal GDP is pretty easy. For ease of understanding, we will assume that there is a small country that produces only one fruit – mangoes.
- Let’s say that a country named “T” produces 1000 kilograms of mangoes in 2015. The price per kilogram is $10. That means, in 2015, the GDP is $10,000.
- Similarly, we will look at the GDP of the country “T” in the year 2016. In 2016, country “T” produces 1300 kilograms of mangoes. And the price increased to $13 per kilogram. That means, in 2016, the GDP is $16,900.
We calculate the nominal gross domestic product to see whether there is any productivity or not. Through it, we will just look at the overall result.
In this case, if we compare the output of 2015 and 2016, we will see that the productivity of 2016 is better since the output is more.
Now, you may ask how come 2016 has become more productive. As per the nominal GDP, it’s based on the market price of the current year. So, we can only compare as per the current market price. That’s why 2016 is more productive. But in reality, the actual growth should be measured by the increase in the quantity produced a year to year. That can only be done in real GDP.
Do have a look at the differences between real GDP and nominal GDP
Advantages
The nominal gross domestic product has a couple of advantages that attract people to calculate the GDP in a nominal way. Let’s have a look at them –
- It’s very easy to ascertain: There’s no complexity in nominal gross domestic product. All you need to understand is the current market price and how much quantity the country has produced during a year. As the current market price is easy to know and the quantity produced during the year can be gathered easily, nominal GDP is easy to calculate.
- Easy to understand: It is easy to understand. If you look at the nominal gross domestic product of two consecutive years, you would be able to tell just by a glance which year is more productive for the country. But the economists don’t think this way. They want to go deep within the productivity of the country. That’s why they prefer real GDP instead of nominal GDP. Thus, it is a preferred choice for the layman, but not for the economists.
Disadvantages
Unfortunately, the disadvantages of nominal GDP are more apparent than the advantages of it. Let’s have a look –
- It doesn’t consider the effect of inflation: This is a big negative. Inflation affects an economy so very intensely. And not considering the effect of inflation in calculating GDP is a big no. Not considering inflation for calculation of nominal gross domestic product may be easier, but not a valid calculation for experts in the field.
- It can’t compare the intricacies of price and quantity: To understand the productivity of the economy, one must compare the result of two years. And it’s not only the total output that matters because the price has always been changing. What matters, rather, is the quantity produced in a year. If we can compare that, then we would be able to understand whether the economy is growing or not. A nominal gross domestic product can’t compare the intricacies of price and quantity.
- It doesn’t compare similar results: Comparing the result of the previous year at the previous year’s market price with the result of this year with this year’s market price isn’t the right thing to do; because there are many factors that have changed or remained same. That’s why we need to take a base price/quantity to reach the right conclusion.
Conclusion
Nominal GDP is sum total of all services, goods and finished products produced in a country. Nominal gross domestic product is very easy to calculate as it based on the current market prices of the goods and it is also very easy to understand. however, its key disadvantages are that it doesn’t consider the effect of inflation and it can’t compare the relationships between price and quantity.
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