Difference Between Nominal and Real
All economic magnitudes can be expressed in real or nominal terms. It is important to know the difference so that we are not deceived when giving news. To explain it, we will follow the example of the difference in nominal or real GDP growth .
In general, the nominal magnitudes are those that are “gross”. Of course, inflation is also important. Precisely what real magnitudes do is subtract the effect of inflation from the nominal magnitude.
When speaking in real terms, it refers to base year prices. That is, a specific year is set as a reference and the prices of the base year of the products to be studied are taken. In this way, the effect of inflation is excluded from the studies . The process to convert a nominal value to real terms is precisely called adjustment for inflation. And thanks to this adjustment, real values are an excellent measure of net purchasing power, regardless of price changes over time.
Speaking in nominal terms, on the contrary, the value of the products is in current prices, that is, taking into account the prices that exist in the market at the time of the study, so we include inflation or loss of capacity of currency purchase.
This is of great importance. Suppose we hear on the news that the economy is growing at a rate of 2% per year, that is, GDP is growing at 2%. In this case we must ask ourselves: Is it real or nominal data?
Real = nominal – inflation
If it is a nominal data, the amount that the economy has grown in monetary units includes both the increase in the quantity of products sold and the increase in their prices.
If a data is real, the price increase will be excluded, since everything is valued at prices of the year taken as a base, therefore, we will only be referring to the number of final units sold, without taking into account the variation in prices. . Hence it is called real, since we observe the physical growth itself.
Then, we must understand that if the economy grows at 2% in nominal terms, but at the same time prices increase at 3%, in reality the economy is decreasing at 1%. Fewer final products are sold at a more expensive price in the country, so there is actually a setback and people are able to buy fewer things with the same amount of money.
It is important to mention that this method (subtracting percentages) is only valid for small percentages. If the percentages are higher, other calculations will have to be used.
Difference between real value, nominal value and market price
It is important to distinguish between real value, nominal value and market price. Depending on the difference between this price paid and the nominal value that was attributed to this asset, we will say that it will have been paid above the nominal value ( above par ), below the nominal value ( below par ), or being exactly equal to face value ( at par ).
For example, the share of a company that was issued with a nominal value of 5 euros and is sold or transferred on the market for 6 euros, will have this last amount as the market price. However, the actual price may be something else entirely. For example, if the company anticipates an increase in profits in the coming years due to an innovation, which is not included in the price, the real value of the share ( intrinsic value ) can be 7 euros.