Real versus nominal value (economics)

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In economics, nominal value is measured in terms of money, whereas real value

is measured against goods or services. A real value is one which has been
adjusted for inflation, enabling comparison of quantities as if the prices of goods
had not changed on average. Changes in value in real terms therefore exclude
the effect of inflation. In contrast with a real value, a nominal value has not been
adjusted for inflation, and so changes in nominal value reflect at least in part the
effect of inflation.

Contents

 1Commodity bundles, price indices and inflation

 2Real value
 3Real growth rate
 4Real wages and real gross domestic products
 5Example
 6Real interest rates
 7Cross-sectional comparison
 8See also
 9Notes
 10References
 11External links

Commodity bundles, price indices and inflation[edit]

A commodity bundle is a sample of goods, which is used to represent the sum
total of goods across the economy to which the goods belong, for the purpose of
comparison across different times (or locations).
At a single point of time, a commodity bundle consists of a list of goods, and each
good in the list has a market price and a quantity. The market value of the good is
the market price times the quantity at that point of time. The nominal value of the
commodity bundle at a point of time is the total market value of the commodity
bundle, depending on the market price, and the quantity, of each good in the
commodity bundle which are current at the time.
A price index is the relative price of a commodity bundle. A price index can be
measured over time, or at different locations or markets. If it is measured over time,

it is a series of values over time .

A time series price index is calculated relative to a base or reference date. is

the value of the index at the base date. For example, if the base date is (the end

of) 1992, is the value of the index at (the end of) 1992. The price index is

typically normalized to start at 100 at the base date, so is set to 100.

The length of time between each value of and the next one, is normally

constant regular time interval, such as a calendar year. is the value of the

price index at time after the base date. equals 100 times the value of the

commodity bundle at time , divided by the value of the commodity bundle at

the base date.
If the price of the commodity bundle has increased by one percent over the first
period after the base date, then P1 = 101.

The inflation rate between time and time is the change in the price

index divided by the price index value at time :

expressed as a percentage.

Real value[edit]
The nominal value of a commodity bundle tends to
change over time. In contrast, by definition, the real
value of the commodity bundle in aggregate remains
the same over time. The real values of individual
goods or commodities may rise or fall against each
other, in relative terms, but a representative
commodity bundle as a whole retains its real value as
a constant from one period to the next.
Real values can for example be expressed in constant
1992 dollars, with the price level fixed 100 at the base
date.
 Comparison of real and nominal gas prices 1996 to 2016,
illustrating the formula for conversion. Here the base year is
2016.

The price index is applied to adjust the nominal

value of a quantity, such as wages or total

production, to obtain its real value. The real value is
the value expressed in terms of purchasing power in
the base year.
The index price divided by its base-year

value gives the growth factor of the price index.

Real values can be found by dividing the nominal
value by the growth factor of a price index. Using the
price index growth factor as a divisor for converting a
nominal value into a real value, the real value at
time t relative to the base date is:

Real growth rate[edit]

The real growth rate is the change in a

nominal quantity in real terms since the

previous date . It measures by how much the

buying power of the quantity has changed over a
single period.

where is the nominal growth

rate of , and is the inflation

rate.

For values of between −1

and 1 (i.e. ±100 percent), we
have the Taylor series

so

Hence as a first-order
(i.e. linear)
approximation,

Real wages
and real
gross
domestic
products[edit]
The bundle of
goods used to
measure
the Consumer
Price Index (CPI)
is applicable to
consumers. So for
wage earners as
consumers, an
appropriate way
to measure real
wages (the buying
power of wages)
is to divide the
nominal wage
(after-tax) by the
growth factor in
the CPI.
Gross domestic
product (GDP) is
a measure of
aggregate output.
Nominal GDP in a
particular period
reflects prices that
were current at
the time, whereas
real GDP
compensates for
inflation. Price
indices and the
U.S. National
Income and
Product
Accounts are
constructed from
bundles of
commodities and
their respective
prices. In the case
of GDP, a suitable
price index is
the GDP price
index. In the U.S.
National Income
and Product
Accounts, nominal
GDP is
called GDP in
 current
dollars (that is, in
prices current for
each designated
year), and real
GDP is
called GDP in
[base-year]
dollars (that is, in
dollars that
can purchase the
same quantity of
commodities as in
the base year).

Example[edit]

If for years 1 and 2 (possibly a span of 20

years apart), the nominal wage and price
level P of goods are respectively
nominal wage rate: $10 in year 1 and
$16 in year 2
price level: 1.00 in year 1 and 1.333
in year 2,
then real wages using year 1 as the
base year are respectively:
$10 (= $10/1.00) in year 1 and $12 (=
$16/1.333) in year 2.
The real wage each year
measures the buying power of
the hourly wage in common
terms. In this example, the real
wage rate increased by 20
percent, meaning that an hour's
wage would buy 20% more
goods in year 2 compared with
year 1.

Real
interest
rates[edit]
Main article: Real
interest rate
 As was shown in
the section above
on the real growth
rate,

where

is the rate of increase of a quantity in real

terms,

is the rate of increase of the same quantity in

nominal terms, and

is the rate of inflation,

and
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