Nominal Dollars Versus Real Dollars (Also Known as Current Dollars Versus Constant Dollars)
Anything measured in dollars can be looked at in two ways. Nominal dollars (also referred to as current dollars) represents the actual amount of money spent or earned over a period of time. You'll see stories mentioning how American factory workers received total pay hikes of $500 million, or a 5% increase, in the last 12 months. Or perhaps you read that company A reported income from sales of sweaters climbed to $220 million that year, up from $200 million the year before, or a jump of 10%. These figures are based in nominal dollars.
However, nominal (or current) dollars gives you only part of the story. What's missing is how inflation can distort such numbers. Let's go back to the example of the earnings of factory workers. They might have seen their pay jump by 5% in nominal terms, but before anyone celebrates, someone should ask this question: "What if the price of goods and services (i.e., inflation) rose by 4% during that same period?" In that case, the wages of these workers rose by a less-than-impressive 1% in real (or constant) dollars. In other words, the actual increase in purchasing power these workers gained from their pay hike was far smaller than 5%.
Let's now look at company A. It noted that sales revenue jumped by 10%. However, that doesn't necessarily mean it sold 10% more sweaters. In fact, the firm ended up selling the same number of sweaters both years. The only reason it received more money in the second year is because the company raised the price of sweaters by 10%. Thus, the increase in real (constant) dollar sales was actually zero!
Nominal dollars simply reflects the present value of goods and services exchanged in the marketplace. However, real dollars tells you the true value of goods and services produced or sold because it strips out the effects of inflation. When economists and investors want to compare the performance of the economy over different time frames, they generally look at both measuresnominal and real. They note the change in the size of the economy in nominal dollars because that points to what individuals, businesses, and the government actually spent. However, to find out if the economy genuinely expanded by producing more in quantity or volume, economists and investors look at the numbers in real-dollar terms.