Nominal and Real GDP

Introduction: What is GDP?

Gross Domestic Product or GDP is the economic value of all goods and services produced in a country within a specified period of time. Calculation of GDP is done on all final goods. This is so because if the value of intermediaries is taken, it may lead to double entry. That is why the value of final goods is taken to measure the value of GDP.

The value of GDP is usually measured yearly; but in some instances, the value may be calculated quarterly as well. GDP is a comprehensive parameter to check the economic health of a country. The value of GDP shows both the size of the economy and the growth of the economy. Therefore, it is one of the most important tools to judge the health of a nation’s economic progress.

Economically, the final users of finished goods and services are categorized into three classes - households, businesses, and government. Therefore, one way to measure the GDP includes these three sectors. The method is known as the expenditure method and the formula for calculating the GDP in this method is:

$$\mathrm{GDP\:=\:Consumption\:+\:Investment\:+\:Government\:spending\:+\:Net\:Export}$$

or

$$\mathrm{GDP\:=\:C\:+\:I\:+\:G\:+\:NX}$$

Where

consumption (C) indicates private-consumption expenditures by nonprofit organizations and households,

investment (I) refers to home purchases by households and business expenditures by businesses,

government spending (G) indicates expenditures on goods and services by the government, and

net exports (NX) indicates the country’s exports minus its imports.

Example – GDP

In the following graph represented by the U.S. Energy Information Administration’s (EIA) International Energy Outlook 2019 (IEO2019), it shows that India has the fastest growing rate of energy consumption globally through 2050.

What is Nominal GDP?

Nominal GDP is the entire amount of the economic output produced in a country in a year valued at the current market price. Nominal GDP does not take inflation into account. Moreover, nominal GDP is based on the current market prices of products.

The value of nominal GDP is higher because it considers the current market value of the goods and services, unlike the base year’s price in the case of real GDP. It is easy to calculate nominal GDP because we just need the current year’s data. Moreover, since inflation adjustment is not required, it becomes even simpler to calculate the value of nominal GDP.

What is Real GDP?

Real GDP of an economy is an inflation-adjusted measure that is the total value of economic output that is accounted for by inflation in comparison to a base year’s price of goods and services.

To calculate real GDP one needs to determine the prices of the goods and services in a base year. The change in GDP in comparison to the base year must be noted first. Then, the inflation must be found for each year and it must be divided out. In this case, even if changes in price do not lead to changes in the output of the economy, the real GDP would still indicate a change.

Therefore, we can state that the economic output of a nation for a specified period of time that takes into account inflation is known as real GDP. As is evident, it is a bit complex to calculate the real GDP. The value of real GDP is lower because it is concerned with the base year instead of the current year. Real GDP is also more popular than nominal GDP.

Real GDP is inflation-adjusted and hence it gives a more accurate picture of the economy than the nominal GDP. However, it is a bit hard to compute since adjustments must be made depending on the base year.

Differences between Nominal and Real GDP

Nominal GDP	Real GDP
Nominal GDP is also known as unadjusted GDP because it is not adjusted for the inflation occurring in the economy. It just shows the value of all finished goods and services that are produced within a geographical location in a year’s time. The value of products usually keeps changing depending on the quantity produced and the price of the commodities.	Real GDP is the GDP that is inflation adjusted in comparison to the prices of goods and services of a base year. Therefore, it can be concluded that the inflation-adjusted nominal GDP and real GDP are identical.
The value of all products and services (finished goods) must be taken to calculate the nominal GDP. Nominal GDP is calculated using the current year’s prices which is the year of production of goods and services.	If the price of products changes with change in the period and the total output remains the same, then there will be no change in the value of real GDP.
The market value of goods and services in a given year that is not adjusted for inflation is the nominal GDP of the economy for that given year.	If no inflation or deflation occurs in an economy over a few years’ time, then the values of nominal and real GDP will be the same.
	The inflation in prices can be calculated using a term known as the GDP deflator. $\mathrm{GDP\:Defiator\:=\:\frac{Nominal\:GDP}{Real\:GDP}\times\:100}$ The GDP deflator is used as an Index that offers insight into inflation or deflation in an economy.

Key Notes

• Unregistered or unadjusted GDP which is also known as nominal GDP is the value of all finished goods and services that are produced within a geographical region in a specified period of time.

• If the prices change from one to the next period while the output remains constant, then the value of nominal GDP would change regardless of whether the output changes or not.

• Real GDP considers the price changes occurring due to inflation in an economy.

• Real GDP is nothing else but nominal GDP that is adjusted for inflation.

• Real GDP will not change if the prices change from one to the next period regardless of the fact whether the value of outputs changes or not.

• The real GDP represents the exact change in the production of an economy.

• Nominal GDP and real GDP will be the same if no inflation or deflation occurs.

Conclusion

It is important to keep an eye on the GDP of nations because the growth in GDP is an indicator of the economic progress of a nation. Moreover, the difference between nominal and real GDP and their uses must also be within the reach of potential economists as they show different characteristics and have different methods of calculation.

FAQs

Qns1.What is meant by GDP?

Ans. Gross Domestic Product or GDP is the economic value of all goods and services produced in a country within a specified period of time.

Qns2.Why is the value of all final goods considered while calculating the value of GDP?

Ans. Calculation of GDP is done on all final goods. This is so because if the value of intermediaries is taken, it may lead to double entry. That is why the value of final goods is taken to measure the value of GDP.

Qns3. Which is the more popular form of GDP, nominal or real GDP?

Ans. Real GDP is a more popular form of GDP than nominal GDP.