Nominal Versus Real
The concepts of nominal and real appear throughout economics, and GDP is no exception. Nominal GDP is reported using current prices. In order for economists to make valid comparisons in GDP from year to year, the price changes that occur with time's passage have to be addressed. Real GDP reports output, holding prices constant. If the change in prices (inflation) is not accounted for in calculating GDP, results may be misleading.
Nominal GDP must be deflated in order to calculate real GDP. Assume an extremely simple economy that produces multicolored beach balls. In 2009, the economy produced 100 beach balls that were all purchased by consumers at $1.00 a piece. In 2010, the economy produced 100 identical beach balls that were all purchased by consumers for $1.25 a piece. Given that information, nominal GDP for each year can be calculated by multiplying the number of beach balls by that year's current price, so in 2009 nominal GDP was $100 and in 2010 it was $125. An outside observer might come to the incorrect conclusion that output increased by 25%. The reality was that output did not change, but prices rose by 25%. To compare what really happened, prices must be held constant. Using 2009 prices, the real GDP for 2009 and 2010 is $100, in other words real output remained constant.