Shawn has a masters of public administration, JD, and a BA in political science.
A nominal term is an unadjusted number of something such as wages, stock prices, assets, and interest rates and is generally described in fixed monetary terms. On the other hand, a real term takes into account changes in price level over time. Real value is a far more accurate measurement of value than nominal value. You can think of nominal value as face value, and face value doesn't always equal real value.
Let's illustrate the difference between nominal and real values with some simple examples. Imagine you find a rare coin with the face value of a $0.01. However, that penny's adjusted value based upon market demand is $2,000. Would you be willing to sell the penny for its nominal value?
Imagine that you loaned a friend $1,000 dollars for one year at an interest rate of 10%. Your nominal rate of return is 10%. However, inflation during the year of the loan was a robust 4%. When you adjust your nominal rate of return to adjust for the inflation, your real rate of return is only 6%.
Let's say you receive a 3% raise in salary. At first, you are fairly happy with the nominal increase in pay - until you find out that the inflation rate for the year was 3.5%, which means that even with your raise, you actually have lost purchasing power.
Importance in Analysis
It's important to understand whether you are looking at a nominal term or a real term. Sound financial and economic analysis often requires you to adjust nominal terms to their real value. This can clearly be seen by reviewing the examples discussed above. A nominal rate of return or a raise in the nominal wage rate may not nearly be as valuable when adjusted for inflation. On the other hand, some assets' real value may greatly exceed their nominal values, as in the case of collectible coins, stamps, and securities.
The term 'nominal' in economics and business generally refers to a number that has not been adjusted to take into account changes in price due to inflation or other factors. In contrast, real value is the value that is adjusted for changes in price. It's often necessary to determine the real value in order to make sound economic and financial decisions on a wide range of matters, from wages to valuation of assets to calculating a return on an investment.
Nominal Topics Overview
|Nominal term||an unadjusted number of something, such as wages, stock prices, assets, and interest rates, that is generally described in fixed monetary terms|
|Real term||takes into account changes in price level over time; real value is a far more accurate measurement of value than nominal value|
|Analysis||sound financial and economic analysis often requires you to adjust nominal terms to their real value|
After this lesson, you should be able to:
- Describe a nominal term
- Explain how real value may be more important
- Give examples of how this works
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