Real vs Nominal Analysis

Real vs Nominal Analysis#

There can be significant confusion when distinguishing between real and nominal analyses in financial or techno-economic studies. This distinction matters because it determines whether and how inflation is accounted for when evaluating costs, revenues, or cash flows.

Key Definitions#

  • Real Analysis: Presents all monetary values in terms of a single reference year (constant dollars).

    • Inflation effects are removed so that results reflect true purchasing power.

    • Useful for comparing values across time without inflation distortions.

  • Nominal Analysis: Presents values in the year dollars they occur (current or actual year dollars).

    • Inflation effects are included since each year’s value reflects that year’s prices.

How Inflation Is Applied#

The application of inflation depends on whether the analysis is historical or predictive (forward-looking):

Type of Analysis

Real Analysis

Nominal Analysis

Historical

Must add inflation to bring past values to the base year (e.g., convert 2010 dollars to 2025 dollars).

Uses recorded values as-is, since historical data are already in their respective year dollars.

Predictive / Forward-looking

Uses current-year values directly — inflation is not added because costs are expressed in today’s dollars (real terms).

Must add inflation to project future year costs or revenues in their actual year dollars.

Example: Five-Year Project with 2% Annual Inflation#

Suppose you are evaluating a project that incurs $1 million in operating costs each year for five years, expressed in today’s dollars (Year 0).

Year

Real Analysis (constant $)

Nominal Analysis (2% inflation)

1

$1,000,000

$1,020,000

2

$1,000,000

$1,040,400

3

$1,000,000

$1,061,208

4

$1,000,000

$1,082,432

5

$1,000,000

$1,104,081

Interpretation:

  • The real analysis shows the same cost every year because it ignores inflation—values are all in Year 0 (today’s) dollars.

  • The nominal analysis escalates costs each year to reflect inflation, showing what you’d actually pay in each year’s currency.

Summary#

In short:

  • Real analysis removes inflation effects — values are in constant dollars.

  • Nominal analysis includes inflation effects — values are in actual year dollars.

  • The direction of inflation adjustment (adding or not adding) flips depending on whether you’re looking backward (historical) or forward (predictive).

All approaches are useful — what matters most is being abundantly clear which one is being applied and consistent across your calculations.

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