What is Real Gross Domestic Product (GDP)?
Real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year (expressed in base-year prices) and is often referred to as "constant-price," "inflation-corrected", or "constant dollar" GDP.
- Real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year (expressed in base-year prices) and is often referred to as "constant-price," "inflation-corrected", or "constant dollar" GDP.
- Real GDP makes comparing GDP from year to year and from different years more meaningful because it shows comparisons for both the quantity and value of goods and services.
- Real GDP is calculated by dividing nominal GDP over a GDP deflator.
Nominal vs. Real GDP
Understanding Real Gross Domestic Product (GDP)
Real gross domestic product is a macroeconomic statistic that measures the value of the goods and services produced by an economy in a specific period, adjusted for inflation. Essentially, it measures a country's total economic output, adjusted for price changes. Governments use both nominal and real GDP as metrics for analyzing economic growth and purchasing power over time.
The Bureau of Economic Analysis (BEA) provides a quarterly report on GDP with headline data statistics representing real GDP levels and real GDP growth. Nominal GDP is also included in the BEA’s quarterly report under the name current dollar. Unlike nominal GDP, real GDP accounts for changes in price levels and provides a more accurate figure of economic growth.
Because GDP is primarily one of the most important metrics for evaluating the economic activity, stability, and growth of goods and services in an economy, it is usually reviewed from two angles - nominal and real. Nominal GDP is a macroeconomic assessment of the value of goods and services using current prices in its measure. Nominal GDP is also referred to as the current dollar GDP. Real GDP takes into consideration adjustments for changes in inflation. This means that if inflation is positive real GDP will be lower than nominal and vice versa. Without a real GDP adjustment, positive inflation greatly inflates GDP in nominal terms.
Economists use the BEA’s real GDP headline data for macroeconomic analysis and central bank planning. The main difference between nominal GDP and real GDP is the adjustment for inflation. Since nominal GDP is calculated using current prices it does not require any adjustments for inflation. This makes comparisons from quarter to quarter and year to year much simpler, though less relevant, to calculate and analyze.
As such, real GDP provides a better basis for judging long-term national economic performance than nominal GDP. Using a GDP price deflator, real GDP reflects GDP on a per quantity basis. Without real GDP it would be difficult to tell just from nominal GDP whether production is actually expanding or just a factor of rising per-unit prices in the economy.
A positive difference in nominal minus real GDP signifies inflation and a negative difference signifies deflation. In other words, when nominal is higher than real, inflation is occurring and when real is higher than nominal, deflation is occurring.
Real GDP Calculation
Calculating real GDP is a complex process typically best provided by the BEA. In general, calculating real GDP is done by dividing nominal GDP by the GDP deflator (R).
Real GDP = Nominal GDP ÷ R
R = GDP Deflator
The BEA provides the deflator on a quarterly basis. The GDP deflator is a measurement of inflation since a base year (currently 2012 for the BEA). Dividing the nominal GDP by the deflator removes the effects of inflation.
For example, if an economy's prices have increased by 1% since the base year, the deflating number is 1.01. If nominal GDP was $1 million, then real GDP is calculated as $1,000,000 / 1.01, or $990,099.