Chapter 6: 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. Obtain the nominal economic data and a corresponding price index like the Consumer Price Index (CPI). 2. Use the formula Real Value = \(\frac{Nominal\ Value}{(Price\ Index\ at\ that\ time\ period / Price\ Index\ at\ base\ year)}\) to convert each nominal value to real value. 3. Convert all nominal values to their corresponding real values. 4. Create a new series using the real values adjusted for inflation. 5. Analyze the real data series, making comparisons over time without the distortion caused by changes in the overall price level.

Step by step solution

Identify the Nominal Data and Price Index

First, you need to obtain the series of nominal economic data that you want to convert to real terms. The data might represent aggregate economic variables, such as GDP, or individual prices. You also need a price index for the same time period, with a chosen base year. The price index reflects changes in the overall price level and is used to bring nominal values into real terms.

Determine the Formula to Convert Nominal to Real

The formula to convert nominal values to real values is as follows: Real Value = \(\frac{Nominal\ Value}{(Price\ Index\ at\ that\ time\ period / Price\ Index\ at\ base\ year)}\) This will give you the real value of the economic data expressed in constant prices based on the chosen base year's prices.

Convert Each Nominal Value to Real Value

Using the formula mentioned in step 2, convert each nominal value in the series to its corresponding real value. Divide the nominal value by the ratio of the price index at that specific time to the base year's price index. Make sure to do this for each time period in the series.

Create a New Series with Real Values

Once all the nominal values have been converted to real values, you can create a new series with these real values. This series will represent the economic data adjusted for inflation, and it will be useful for comparing values over time without the distortion caused by changes in the overall price level.

Analyze the Real Data Series

Now that you have converted the nominal data to real terms, you can perform various analyses on the real data series. Comparisons made with real values allow for a better understanding of changes in economic variables over time, as these comparisons eliminate the effects of inflation. For example, you can compare real GDP growth across different time periods to analyze the relative health of an economy during those periods, or you can compare real wages to see how changes in compensation have evolved in real terms.