Introduction

Definition: The nominal price of a good is its value in terms of money, such as dollars, French francs, or yen. The relative or real price is its value in terms of some other good, service, or bundle of goods. The term relative price is used to make comparisons of different goods at the same moment of time. The term real price tends to be used to make comparisons of one good to a group or bundle of other goods across different time periods, such as one year to the next.

Examples:

• Nominal price: That CD costs $18. Japan’s science and technology spending costs its taxpayers about 3 trillion yen per year.
• Relative price: A year of college costs about the value of a Toyota Camry. Those tickets to see Lady Gaga cost me three weeks’ worth of food.
• Real price: The real price of coffee rose in the last year, so to buy a pound of coffee I now have to skip a day of croissants or buy fewer songs on iTunes. My cost of living rose 2% last year in real terms.

When we say that the relative price of computers has fallen in recent years, we mean that the price of computers relative to or measured in terms of other goods and services —such as TVs, cars, tickets to the Super Bowl, or how many hours you have to work to buy a computer—has declined. The opportunity cost has fallen.

When economists talk about prices, they always mean relative or real prices, even if they use dollars to express themselves succinctly in conversation. Most of the time, you can be pretty sure that if the nominal price of a bag of chips goes up from $1.00/bag to $1.05/bag (that is, by 5%), its relative price when compared to other goods has also increased by 5%. Economists usually give examples using nominal prices because nominal prices are familiar and easy to understand. Nominal prices are the equivalent of relative prices except in times of inflation.

Although the real price of a good or service is just another term for its relative price, the term real price can be a little confusing. It tends to used to make comparisons of groups or bundles of goods and services across time.

Let’s say every month you go to the store and buy the same group of things—say, 4 bottles of soda, 2 bags of chips, 1 jar of salsa, and 1 pack of paper plates. You can compare the total price of that bundle from one month to the next. Suppose for several months the bundle always costs you $10/month. Maybe one month soda costs a little more and chips a little less, while the next month the chips cost a little more and the soda a little less, but the total is always $10. That is, the relative prices of soda and chips change from month to month, but the whole bundle costs the same amount each month.

Economists describe this common occurrence by saying there is no change in the real price of your bundle. Nothing changes on average from one month to the next.

Now suppose that suddenly one month the price of the whole bundle increases and you have to pay $11. Economists describe this by saying that the real price has risen by 10% (because [$11-$10]/$10 = 10%). They alternatively say that the bundle went up by 10% in real terms. Compared to the previous month, that same bundle of goods increased in price.

If you happen to include enough goods and services in the bundle, you could alternatively say there was a 10% inflation. Inflation means that the nominal prices of all goods and services in the economy increase on average. A 10% inflation means that the nominal cost of a bundle of everything you buy in total—including your rent, bus fare, movie tickets, food, etc.—has risen by 10%. (You could equally well describe this by saying your cost of living increased.)

Economists don’t have time to track your personal purchases, but they do track the prices of some very large bundles of goods and services and thereby create estimates of inflation. They use those estimates to adjust for inflation. If economists say that the real, or inflation-adjusted price of chips went up, they mean that the price of chips went up by more than overall inflation. That is, if the price of chips rises from $1/bag to $1.30/bag, and inflation or the average price of goods and services rose by 10%, the inflation-adjusted increase is only $.20 a bag (because the portion of the increase due to overall inflation would be 10% or $.10 more per bag).

Definitions and Basics

Real versus nominal value. at Answers.com In economics, the nominal values of something are its money values in different years. Real values adjust for differences in the price level in those years. Examples include a bundle of commodities, such as Gross Domestic Product, and income. For a series of nominal values in successive years, different values could be because of differences in the price level. But nominal values do not specify how much of the difference is from changes in the price level. Real values remove this ambiguity. Real values convert the nominal values as if prices were constant in each year of the series. Any differences in real values are then attributed to differences in quantities of the bundle or differences in the amount of goods that the money incomes could buy in each year. Gross Domestic Product. from the Concise Encyclopedia of Economics In practice BEA first uses the raw data on production to make estimates of nominal GDP. or GDP in current dollars. It then adjusts these data for inflation to arrive at real GDP. But BEA also uses the nominal GDP figures to produce the income side of GDP in double-entry bookkeeping. For every dollar of GDP there is a dollar of income. The income numbers inform us about overall trends in the income of corporations and individuals. Other agencies and private sources report bits and pieces of the income data, but the income data associated with the GDP provide a comprehensive and consistent set of income figures for the United States. These data can be used to address important and controversial issues such as the level and growth of disposable income per capita, the return on investment, and the level of saving. Real vs. nominal interest rates: Interest. by Burton G. Malkiel. Concise Encyclopedia of Economics People’s willingness to lend money depends partly on the inflation rate. If prices are expected to be stable, I may be happy to lend money for a year at 4 percent because I expect to have 4 percent more purchasing power at the end of the year. But suppose the inflation rate is expected to be 10 percent. Then, all other things being equal, I will insist on a 14 percent rate on interest, ten percentage points of which compensate me for the inflation. Economist Irving Fisher pointed out this fact almost a century ago, distinguishing clearly between the real rate of interest (4 percent in the above example) and the nominal rate of interest (14 percent in the above example), which equals the real rate plus the expected inflation rate.