Real Versus Nominal Value (economics)
In economics, nominal value refers to an economic value expressed in fixed nominal money terms (that is, in units of a currency) in a given year or series of years. By contrast, real value adjusts nominal value to remove effects of general price level price changes over time. For example, changes in the nominal value of some commodity bundle over time can happen because of a change in the quantities in the bundle or their associated prices, whereas changes in real values reflect only changes in quantities.
Real values over time are a measure purchasing power net of any price changes over time. They are often used for restating nominal income to real income, thus adjusting that part of income changes that merely offset inflation (a general increase in prices). Similarly, for aggregate measures of output, such as gross domestic product (GDP), the nominal amount reflects production quantities and prices in that year, whereas real amounts in different years reflect only changes in quantities. A series of real values over time, such as for real GDP, measures relative quantities over time expressed in prices of one year, called the base year (or more generally the base period).
In a related fashion, the real value of a commodity bundle in a given year may be derived from its nominal value by replacing then-current prices of commodities in the bundle with prices that prevailed in the base year. Real values in different years then express values of the bundles as if prices had been constant for all the years, with any differences due to differences in underlying quantities.
The nominal value of a commodity bundle in a given year may be expressed in prices and quantities, namely, as a sum of prices times quantities for the different commodities in the bundle. In turn nominal values are related to real values by the following arithmetic definition:
- nominal value / real value = P x Q / Q = P.
Here P serves as a price index, and Q serves as a quantity index of real value. In the equation, P is constructed to equal 1.00 in the base year. Alternatively, P can be constructed to equal 100 in the base year:
- (nominal value / real value) x 100 = P.
note: the base year can be any year but government economists usually uses the same base year for 5 consecutive years. In Canada, a base year was 2002 then 2007 and Canadians will continue using 2007 as a base year up until 2013.
The nominal/real value distinction can apply not only to time-series data, as above, but to cross-section data varying by region, for example a cost-of-living index.
Read more about Real Versus Nominal Value (economics): Illustration, Notation, and Generalization, Uses and Examples, Interest Rates
Famous quotes containing the words real and/or nominal:
“Perhaps the facts most astounding and most real are never communicated by man to man.”
—Henry David Thoreau (1817–1862)
“Discourage litigation. Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser—in fees, expenses, and waste of time. As a peacemaker the lawyer has a superior opportunity of being a good man. There will still be business enough.”
—Abraham Lincoln (1809–1865)