Nominal & Real GDP (2 GDP Measures)

Nominal GDP vs Real GDP

Introduction

In our previous articles, we have seen what is GDP, how it is calculated, what are the methods of GDP calculation. There are 2 measures in which GDP can be expressed- Nominal GDP & Real GDP. Lets discuss the difference between Nominal GDP & Real GDP in this article.

Understanding Nominal & Real GDP using Hypothetical Eample

• Let us assume Country A, which only produces Apple. Now, the GDP of the country would be the quantity of apple multiplied by the price of apple. Let us assume country A produces 100 apples in year 1. The selling price of 1 apple being rupees 10.
• As the country produces only apples and no other product, the GDP of the country would be: GDP (year 1) = Quantity of apple * price of apple = 100 * 10 = 1000 rupees
• In year 2, suppose country A produces 110 apples. The selling price of apple now is 12 rupees. GDP (year2) = 110 * 12 = 1320 rupees
• Now, what does 1320 indicates. Is this the nominal or the real GDP of the country? This is the nominal GDP of country A. Now, the increase in GDP from 1000 to 1320 is not just because of the increase in quantity from 100 to 110 but also because of the increase in price from 10 to 12 rupees.
• So, if we want to know real growth of country’s economy, then we must calculate the GDP of country A of year 2 in prices of year 1. So, now price = 10 and quantity = 110 Therefore, GDP = 110*10 = 1100 rupees
• Now the difference between real and nominal GDP can clearly be seen, 1320 is the nominal GDP of country A and price adjusted 1100 is the real GDP of the country A. So, we can say that the real growth in GDP is 10% i.e., from rupees 1000 to 1100.

Nominal GDp

• Nominal GDP is an economic metric that measures the total market value of all finished goods and services produced by a country at their current market prices in a single year.
• It is defined as a GDP measure, expressed in absolute terms. The raw GDP data, before inflation is called Nominal GDP.
• Nominal GDP is the aggregate monetary value of the economic output produced during a particular financial year, within the nation’s border. It represents the GDP at prevailing prices in the market, i.e. the current market price.
• It includes all the changes in the prices of finished goods and services that took place in one year due to inflation or deflation.

Real GDP

• Real GDP, also known as inflation-adjusted GDP, measures the value of finished goods and services at constant base-year prices. The real GDP is inflation-adjusted or deflation with the use of nominal GDP and the GDP deflator.
• GDP deflator is a factor by which Nominal GDP is adjusted to calculate Real GDP. It adjusts gross domestic product by removing the effect of rising prices. It shows how much an economy’s GDP is really growing.
• Formula is : GDP Deflator = ( Nominal GDP / Real GDP ) * 100
• This includes changes in the general price level in a given year to provide an accurate picture of an economy’s growth using base-year prices. If the general price level changes from one year to the next, it is difficult to compare the amount of output across different years.
• By valuing the entire output of an economy using the average price of a base year, economists can use this measurement to analyze an economy’s purchasing power and growth potential in the long-term.
• Real GDP is considered as a true indicator of country’s economic growth. It exclusively considers the production and free from price changes or currency fluctuations.
• The real GDP reflects the nominal GDP of an economy if there were no prices changes due to inflation.

India’s Real & Nominal GDP 2015 to 2016

• Taking real GDP values of India, from 2015 to 2016 the nominal GDP increased from 136.75 trillion to 152.51 trillion in Indian rupees term i.e., an increase of around 11.5%. These values in US$ are 2.112 Trillion and 2.264 Trillion. When we refer to a country’s GDP, it is mostly this nominal GDP in USD which is referred. So if someone asks what is India’s GDP, then in 2016, it is 2.264 trillion dollars. But , This 11.5% can not be referred as GDP growth as it includes inflation component as well.
• We have not mentioned the growth in terms of USD here as these two values cannot be compared due to change in exchange rates in separate years. Hence there is no relation between the nominal GDP of two years in other currency terms.
• Therefore whenever, growth of GDP is mentioned it is mentioned by comparing Real GDP of two years because to calculate real GDP a ‘base year’ is chosen and then value from that year forward will be considered to determine the actual growth in GDP after adjusting for inflation
• Real GDP is always calculated & referred to a constant US Dollar or Rupee price of a particular year.
• India’s real GDP increased from 2.301 trillion dollars to 2.465 trillion dollars at 2010 constant Dollars i.e., an increase of around 7.1%. So this figure is always referred as GDP growth value.
• For developing countries, where there is high inflation, Real GDP value is always lower than Nominal value but here in dollar terms it is coming higher. Because exchange rate difference between 2010 on which Real GDP is calculated and 2015/2016 on which Nominal GDP is calculated was very high.

Comparing Nominal GDp and Real GDP

Common Misconceptions

• An increase in GDP does not necessarily mean a nation has produced more output; it must be specified whether the GDP in question is nominal or real.
• An increase in nominal GDP may just mean prices have increased, while an increase in real GDP definitely means output increased.

Summary

• Nominal GDP and Real GDP both quantify the total value of all goods produced in a country in a year. However, Real GDP is adjusted for inflation, while Nominal GDP is not. Thus, real GDP is almost always slightly lower than its equivalent nominal figure.
• In most circumstances, the Real GDP shows a more accurate picture of a country’s economic performance. Because we can more easily compare it to past year figures.Thus, we can deduce whether a country really is better or worse off year over year.