Understanding the Difference between Nominal and Real GDP
Gross Domestic Product (GDP) is one of the most commonly used economic indicators. It represents the total value of goods and services produced in a country during a certain period of time. GDP is an important yardstick that measures the overall economic health of a country.
However, there are two different ways of measuring GDP – nominal GDP and real GDP. Although they may sound similar, they are actually quite different. In this article, we will explore what nominal and real GDP are and what sets them apart.
What is Nominal GDP?
Nominal GDP, also known as current dollar GDP, is the value of goods and services produced in a country during a certain period of time, expressed in current prices. It simply measures the GDP without taking inflation into consideration. In other words, nominal GDP is the raw total of goods and services produced in a country.
For instance, suppose a country’s nominal GDP in 2019 was $20 trillion, and in 2020, it increased to $22 trillion. This would suggest that the country’s economy grew by $2 trillion in a year.
What is Real GDP?
Real GDP, also known as constant dollar GDP, is the value of goods and services produced in a country during a certain period of time, adjusted for inflation. Real GDP takes into account fluctuations in prices and is, therefore, a more accurate measure of economic growth over time. In other words, real GDP reflects the economic growth adjusted for inflation.
Using the same example as above, let’s assume that inflation increased by 3% in the year 2020. In this case, the country’s real GDP growth would be calculated as $22 trillion (nominal GDP) – 3% (inflation rate) = $21.34 trillion (real GDP). This means that the country’s actual economic growth was $1.34 trillion instead of $2 trillion, which it would have seemed if only nominal GDP was taken into consideration.
Key Differences between Nominal and Real GDP
– Nominal GDP is raw total of goods and services produced in a country, while real GDP is adjusted for inflation.
– Nominal GDP does not reflect the changes in prices over time, while real GDP does.
– Real GDP is a more accurate measure of economic growth over time, while nominal GDP is merely a snapshot of the economy at a specific point in time.
– Real GDP takes into account changes in prices, making it more useful in comparison across years.
In conclusion, while nominal GDP is a simple and straightforward way of measuring economic output, it can be misleading because it does not take inflation into account. To have an accurate picture of the growth or decline in a country’s economy, real GDP is a more appropriate measure to use.
Table difference between nominal and real gdp
| Parameter | Nominal GDP | Real GDP |
|---|---|---|
| Definition | The value of goods and services produced in a country, measured in current or nominal prices. | The value of goods and services produced in a country, adjusted for inflation and measured in constant or real prices. |
| Calculation | Price x Quantity | Quantity x Base Year Price |
| Adjustment for inflation | No adjustment made. | Adjusted for inflation using a price index. |
| Usefulness in economic analysis | Useful for tracking the growth rate of the economy over time and comparing the economic performance of different countries. | Allows for meaningful comparisons of economic performance over time and across countries as it reflects changes in output as well as the impact of inflation. |