Alright, let's go into more detail about nominal GDP and real GDP. We've been talking about GDP quite a bit up to this point, and it's important to remember the value of final goods and services produced. We've mentioned two types of calculations: nominal and real GDP. Nominal GDP uses current prices when calculating the value of these final goods and services, whereas real GDP uses what we're going to call base year prices. We use a constant price in real GDP, the base year. We pick some year and use the prices from that year for all the different years' calculations of GDP. That keeps the price side of the calculation constant, and we can measure more the production, the quantity of production that has changed.
When we first discussed GDP, the formal definition, we noted the expenditures approach, right? GDP was calculated as consumption plus—you guys should know this by now—what's the I? The I is investment. Next, government purchases. I'm going to put gov purchases. And finally, what's the NX? It's our net exports.
But a lot of times in this course, when they have you calculate nominal GDP and real GDP, they're going to have some sort of simple economy that's only producing a few goods, and they want you to calculate what is the nominal GDP or real GDP. So what you're going to want to do is get the quantity of each good. For nominal GDP, the quantity of that good uses current prices. So the current price of that good and we're going to do that for each good and add them up. Quantity times price gets us the total value of that good. Notice the only difference with real GDP is that we use base prices. So the quantity of that good this year, times the price in the base year. So the easiest way to see this is in an example, and you're going to see that this is actually pretty easy to do and you can expect to see some kind of question similar to this on the test.
Let's go through this one. The simple economy of Clutchtopia produces three final goods and services necessary for the survival of its citizens, the Clutchtopians. They produce pizza, caffeine pills, and exam reviews. Using the information in the following table, compute nominal GDP and real GDP for 2018, and we're going to assume they're going to have to tell you something like this. Assume that the base year is 2006. So remember, that's going to come into play when we're doing real GDP. For the calculation of real GDP, we'll use base year prices. Nominal GDP uses just current year prices. So let's go ahead and do nominal GDP and real GDP for 2018. For nominal GDP, we add up the quantity times the price for each of these. Let's start with pizza. In 2018, we produced 220 pizzas, and for nominal GDP, we use the current year price, which was $10, giving us the GDP from pizza. Next, caffeine pills, we had 1,500 caffeine pills valued at $4 each. Finally, in 2018, there were 130 exam reviews valued at $20 each. So this isn't too complicated. We're just taking the quantity times the current year price. Adding all three together gives us a nominal GDP of 10,800.
Now, let's go ahead and do real GDP for 2018. The only difference in this calculation is going to be the price that we use. In real GDP, we use the base year price, which is the price in 2006. We still produced 220 pizzas but at the base year price of $8, 1,500 caffeine pills at $5 each, and 130 exam reviews at $15 each. Our final answer for real GDP is 11,210, slightly different because it used different prices reflecting the economic conditions of 2006.
Real GDP tends to be generally the more accepted method because it holds prices constant, making it easier for us to compare the GDP in 2018 to say, the base year of 2006 or any other year because we're using those same prices each year, and we can focus more on that change in quantity. It's usually seen as a better measure of changes in production, rather than nominal GDP. However, one drawback is that the prices of items relative to each other could change. For example, in 2006, the price of HDTVs when they first came out was more expensive, but as technology has improved, producing HDTVs has become cheaper, and the price of HDTVs has come down quite a bit, while the price of milk has stayed relatively constant. This could affect how we look at the value that HDTVs add to GDP compared to milk. To solve this problem with real GDP using a constant price, we use what's called chain-weighted prices. However, that's beyond the scope of this course, so it kind of adjusts the prices and gives us a better estimate of what the price should be. However, overall, you're not going to have to do the chain-weighted calculation. It'd be more familiar with what we just did above in the example. Let's pause here and let's talk about more on nominal GDP and real GDP in the next video.
