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The process is called conversion of nominal values into real value or conversion of national income from current to constant prices. This process can be applied to all national aggregates uniformly and thus nominal GDP, GNP, NNP, NNI etc. can be converted into their respective real values. Generally, national income is symbolically denoted as Y. For example take Y1 and Y0 as the national income values measured in current prices of respective years (say P1 and P0). In this case Y1 and P1 are national income and price values of the current year and Y0 and P0 are similar values of the base year or of the initial year with which the comparison is to be made. Then when Y1 value is converted into P0 price, such a conversion is known as translating nominal income Y1 (n) into real income Y1 (r). Let us assign numerical values to these variables:
But part of this income is only nominal and not real because of the corresponding rise in the price (from 4 to 5). This is clear if we divide each year’s nominal income value by the respective prices. In this way we can obtain real or physical variations in the units of goods produced. Thus in the year Y0 physical units of goods produced are Y0/P0 = 1600/4 = 400 and in the year Y1 it is Y1/P1 = 2400/5 = 480. Therefore real or physical increase in the volume of output produced is only 80 over 400 or it is 80/400 100 (that is 20%). This is exactly the extent of increase in the real income shown by Y1 (r).
20 percent is the increase as desired. Therefore conversion of current to constant price or nominal into real income value by multiplying it by P0/P1 ratio makes the comparisons realistic and enables to remove the element of inflationary price rise. The process is also therefore known as deflating current income into constant prices.
c) Deflator and rate of inflation: Deflator refers to the extent to which nominal income has been deflated or reduced in its value in order to convert it into its real value. It is a coefficient computed as follows:
In our example the value of the deflator will be,
or the deflator value is 25 percent. This is exactly the same proportion in which the prices of the two years have altered.
P1/P0 = 5/4 100 = 125 or 25 percent
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