Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Watching a nation’s GDP flow

GDP is the same thing as aggregate annual income; therefore, it must be a flow variable: one that’s measured per unit of time – yearly, in this case (see Chapter 2 for more on flow (and stock) variables).

The great thing about the ‘GDP cake’, therefore, is that a new one is ‘baked’ every year and every year you get a slice: every year, you get a share of the UK’s national output in the form of income. (Of course, different people get different sized slices – something we discuss later in the ‘Getting Out What You (Marginally) Put In’ section.) If (in the aggregate) people consume less than their income, this adds to a nation’s wealth. So, although the UK’s GDP is around £1.5 trillion, its total wealth is around £10 trillion.


Be wary when you hear people compare the size of a country’s economy to the size of large corporations. You know the sort of thing: ‘Company X is now so large that it’s bigger than the entire Norwegian economy’. These statements are usually misleading, because they typically compare a country’s GDP (a flow variable measured every year) to the total value (market capitalisation) of a firm (all its assets, basically its wealth, which is a stock variable). A more appropriate comparison would be to compare the wealth of a country to the value of a firm. In this case, the world’s large economies dwarf even the largest corporations.

Distinguishing real and nominal GDP

In this section we distinguish between real and nominal GDP and go on to explain why real GDP is the focus of economists’ attention.

Suppose that GDP in the UK last year was calculated to be £1 trillion. Suppose, further, that this year the economy experienced a lot of inflation – so much so that the price of everything doubled. Plus, imagine that the total quantity of goods and services produced this year is the same as last year. The question is: what’s GDP this year?

Well, because the price of everything doubled and the quantity of goods remained the same, you could argue that GDP is now £2 trillion (that’s the ‘value’ today of everything being produced). But that doesn’t sound quite right, does it? The economy is producing just as much this year as last year and yet GDP appears to have doubled!

In such a situation economists say that, although nominal GDP has doubled, real GDP has remained unchanged. Here’s the difference:
Nominal GDP: Measured using current prices – that is, the prices that were current at the time.


Real GDP: Measured using constant prices – which means that an arbitrary year is chosen to be the base year and GDP in all other years is calculated on the basis of prices in the base year.