By Daniel Richards, Manzur Rashid, Peter Antonioni

Remember, you’re imagining gross domestic product (GDP) as one single good. If that were really the case — if, say, you only produced oil — you’d have no trouble saying that if you produced 1,800 billion barrels of oil this year and next year, your real production hasn’t increased, even if oil prices doubled from $10 to $20.

You would just divide the second year values by 2 to make the comparison. That same logic should apply to your fictitious single good called GDP.

What economists are really interested in then is the actual amount of stuff — barrels of oil or pounds of sugar or units of GDP — that the economy is producing in a year. As the oil example indicates, to calculate that value, you have to purge your nominal GDP measure of price movement effects. If you don’t correct the nominal GDP values, you won’t know whether say a 5 percent increase happened because

  • The price level is unchanged and the actual quantity of goods being produced increased by 5 percent; or
  • The price level increased by 5 percent and the actual quantity of goods being produced remained unchanged; or
  • The price level increased by 10 percent and the actual quantity of goods being produced fell by 5 percent; or
  • Some other combination of price level and real GDP changes.

From the viewpoint of real production and what people have available to them for consuming (or saving), the preceding scenarios are all very different, even though in all three cases nominal GDP has risen by 5 percent. Real GDP, however, has increased by 5 percent in the first case, remained unchanged in the second case, and fallen by 5 percent in the third case. Economists think that people should care about the amount of goods being produced rather than the nominal value of those goods, and so the changes in real GDP are what really count.