An Introduction to Nominal GDP and Real GDP
Gross Domestic Product (GDP) measures the total value of goods and services produced within a country in a specific financial year. It also includes the income earned by foreign citizens within the country and excludes a small portion of income earned by the country’s residents abroad.
When GDP is measured at current market prices, it is called Nominal GDP. On the other hand, Real GDP is calculated using fixed prices, adjusted for inflation, to give a more accurate picture of economic growth.
Both Real GDP and Nominal GDP are essential tools for assessing a country's economic growth and development. This article explores the key differences between Real GDP and Nominal GDP from the Commerce Study Materials to clarify their importance. Before we go into the Difference between Real GDP and Nominal GDP let’s have a look at them individually.
Nominal GDP and Real GDP
Real GDP
Real GDP is the total value of all goods and services produced in a country, adjusted for inflation. It measures economic output using constant prices from a base year, which helps to show the true growth of the economy by excluding the impact of rising prices. Also known as inflation-adjusted GDP or constant price GDP, Real GDP is considered a more accurate indicator of a nation’s economic health because it focuses solely on production without being influenced by changes in price levels.
Nominal GDP Definition
Nominal Gross Domestic Product (GDP) is the total value of all goods and services produced in a country, measured using current market prices. It represents the financial worth of everything made within a specific time. Unlike Real GDP, Nominal GDP includes changes in price levels, meaning it can increase simply because prices have gone up, not necessarily because more goods and services are produced. Economists often adjust Nominal GDP to calculate Real GDP, which removes the effects of price changes and provides a clearer picture of economic growth.
Now that we have seen what is Real GDP and Nominal GDP, let’s look at the differences between these two.
Difference between Nominal GDP and Real GDP with Example
Real GDP and Nominal GDP Formula
Nominal GDP Formula
Nominal GDP measures the total value of all goods and services produced in a country using current-year prices. It does not account for inflation or price changes over time.
Nominal GDP = ∑ ( Price of Each Good in the Current Year × Quantity of Each Good Produced )
Example: If a country produces 100 cars at $20,000 each in 2023:
Nominal GDP = 100 × $20,000 = $2,000,000
Real GDP Formula
Real GDP adjusts Nominal GDP for inflation, using constant prices from a base year. This provides a more accurate picture of economic growth by showing changes in production volume without the effects of price changes.
Real GDP= ∑ (Price of Each Good in Base Year × Quantity of Each Good Produced )
Example: Using the same country producing 100 cars, but the base year price is $18,000:
Real GDP = 100 × $18,000 = $1,800,000
Conclusion
In conclusion, Real GDP and Nominal GDP are both important for understanding a country's economic performance. While Nominal GDP measures the value of goods and services at current prices, Real GDP adjusts for inflation to provide a more accurate picture of economic growth. Real GDP is preferred for comparing growth over time as it removes the effects of price changes, making it a clearer measure of actual economic progress.
FAQs on Real GDP and Nominal GDP
1. Why is Real GDP considered more accurate than Nominal GDP?
Real GDP removes the effects of inflation, providing a clearer view of an economy's actual growth over time.
2. How does inflation affect Nominal GDP?
Inflation causes an increase in the overall price level, which can make Nominal GDP appear higher even if the actual quantity of goods and services hasn't increased.
3. Why do economists use Real GDP instead of Nominal GDP?
Economists use Real GDP to measure economic growth accurately, as it removes the impact of price changes over time, showing actual changes in output.
4. What is the GDP deflator?
The GDP deflator is a price index used to adjust Nominal GDP to Real GDP by accounting for inflation.
5. How do you convert Nominal GDP to Real GDP?
To convert Nominal GDP to Real GDP, you divide Nominal GDP by the GDP deflator and multiply by 100.
6. Can Nominal GDP and Real GDP be the same?
Yes, they can be the same in a year where there is no inflation, as there would be no need for adjustments.
7. Which one is more useful for comparing economic growth over time?
Real GDP is more useful as it adjusts for inflation, allowing for a more accurate comparison of economic growth across different periods.
8. How does Real GDP account for price changes?
Real GDP uses constant prices from a base year to calculate the value of goods and services, removing the effects of inflation or deflation.
9. Is Nominal GDP used in economic forecasting?
While Nominal GDP is used to measure the size of an economy in current terms, Real GDP is preferred for long-term forecasting and comparison.
10. What happens to Nominal GDP if inflation increases?
Nominal GDP will rise with inflation, even if the actual production of goods and services doesn’t increase.
