Chapter 19: Problem 16

How do you convert a series of nominal economic data over time to real terms?

Short Answer

Expert verified

To convert a series of nominal economic data over time to real terms, follow these steps: (1) Gather the nominal data and an appropriate price index (e.g., CPI or GDP deflator). (2) Choose a base year. (3) Obtain the price index or deflator value for the base year. (4) Convert each nominal data point to a real value by dividing the nominal value by its corresponding year's price index and multiplying by the base year's index value: \(Real\ value = \frac{Nominal\ value}{Price\ index} \times Base\ year\ index\). (5) Analyze and interpret the real data to reveal more accurate trends and changes in economic activity over time, accounting for inflation.

Step by step solution

Identify the nominal data and price index

First, gather the nominal economic data series you want to convert to real terms. You will also need a price index or deflator, which reflects the price level changes over time. Commonly used price indices are the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) deflator.

Choose the base year

Select a base year to which the nominal data will be adjusted. The base year is usually a year in which no significant economic events occur. In most situations, a base year is provided, or you can choose the first year in your data series as the base year.

Calculate the price index or deflator for the base year

For your chosen base year, find the value of the price index or deflator. This value will typically be provided, or you can calculate it if you have the necessary data. Note that in some cases, the price index or deflator might already be set to 100 for the base year by the data source.

Convert the nominal data to real values

Divide each nominal data point by the corresponding year's price index or deflator and multiply by the base year's index or deflator value: Real value = (Nominal value / Price index) x Base year index Perform this calculation for each data point in the series to convert it to real terms.

Analyze and interpret the results

Now that the nominal data has been converted to real terms, analyze the changes and trends within the data series. By adjusting for inflation, real data will provide a more accurate comparison of economic activity over time. For example, if you find that real GDP has grown consistently over the years, this indicates that the economy has experienced real growth and not just an increase in nominal terms due to inflation.