Question

Use an equation to explain how the growth of nominal gross domestic product (GDP), the growth of real GDP, and the change in price level are related. Give an example.

Answer 1

Nominal GDP measures the market value of domestically produced final goods at current prices while real GDP measures the same value at base year prices. Price level changes are measured by GDP deflator or CPI

We take GDP deflator as a measure of price level changes. We then have GDP deflator = Nominal GDP/Real GDP

In terms of growth, we have

growth rate of price level = growth rate of nominal GDP - growth rate of real GDP

For example, if nominal GDP grows at 8% and real GDP grows at 5% then inflation rate is 8% - 5% = 3%.