Nominal vs Real GDP
There are a number of economic measures that are used to determine variable aspects of an economy. GDP is one of the most commonly used economic measures that represent the strength of an economy by showing the value of the total goods and services that are produced by a country. There are different forms of GDP calculation known as real GDP and nominal GDP, which are calculated slightly differently to one another. The following article provides a clear understanding of how each form of GDP is calculated, how they are different to one another and what they represent about a country’s economy.
Nominal GDP
GDP is the measure of the total goods and services produced by a country. One very important part of the GDP calculation is the price that is attached to the goods produced. Let’s take one glove producing factory’s GDP as an example. The factory produces 1000 gloves a month, at $5 per glove then the GDP for this factory for one month would be $5000 (which will add onto to the country’s total GDP). If the glove cost just $4, then the GDP would be just $4000 even though the same amount of gloves was produced.
Keeping the above example in mind, nominal GDP does not take into account the changes in prices and is calculated at current market prices for that month or quarter. This means that the nominal GDP calculation does not take into account inflation or deflation (inflation is when the price levels of all goods and services keeps increasing and deflation is when price levels keep falling).
Real GDP
Real GDP, on the other hand, takes into account the effects of inflation and deflation. For example, the nominal GDP of a country was $800 Billion in 2011, but this year the country’s GDP is $840 Billion and shows an increase of 5%. The country’s inflation level is currently at 2%. To calculate the real GDP this 2% inflation would have to be stripped out to give a real GDP of $823 Billion. Since this value does not include inflationary effects it can be compared to GDP values across a number of years.
Nominal vs Real GDP
Real GDP and nominal GDP are both very important calculations made to understand the strength of a country’s economy. The nominal GDP measures the value of total goods and services produced in an economy in current monetary terms, whereas real GDP measures the value of goods and services after removing all inflationary effects.
Nominal GDP is useful in understanding the actual value of goods and services that a country produces or that a person can afford at the current period of time, and shows what currency can actually buy. Real GDP is useful because it shows the actual production of goods and services and not the fluctuations in the value of the currency or changes in price levels.
Summary:
What is the difference between Real GDP and Nominal GDP?
• GDP is one of the most commonly used economic measures that represent the strength of an economy by showing the value of the total goods and services that are produced by a country.
• Nominal GDP does not take into account the changes in the prices (due to inflation/deflation) and is calculated at current market prices for that month or quarter.
• Real GDP, on the other hand, takes into account the effects of inflation and deflation and shows the actual value of the total goods produced.