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" GDP or "constant dollar GDP." Unlike nominal GDP, real GDP can account for changes in price level and provide a more accurate figure of economic growth.
- Real GDP is a measure of a country's total economic output that is adjusted for price changes.
- Real GDP makes comparing of GDP in different years more meaningful, because it allows comparisons of the actual volume of goods and services without inflation.
- Real GDP is calculated using a deflator or price index, a number that expresses prices in each year relative to a base year.
Nominal vs. Real GDP
Understanding Real Gross Domestic Product (GDP)
Real gross domestic product is a macroeconomic assessment that measures the value of the goods and services produced by an economic entity in a specific period, adjusted for inflation. GDP is derived by valuing all production by an economy using a specific year's average prices. Governments use GDP as a comparison tool to analyze an economy's purchasing power and growth over time. This is done by looking at the economic output of two periods and valuing each period with the same average prices and comparing the two together.
Real GDP Versus Nominal GDP
Nominal GDP is a macroeconomic assessment that includes current prices in its measure. The main difference between nominal GDP and real GDP is the adjustment for prices from year to year. Since nominal GDP is calculated using prices in that year and does not account for inflation, it can make comparisons from one year to another less useful.
Because GDP is measured in the monetary value of goods and services produced, it is subject to change if prices change. Falling prices will tend to decrease nominal GDP and rising prices will make nominal GDP look larger. But these changes may not reflect any change in the quantity or quality of goods and services produced. Because of this, it is difficult to tell just from nominal GDP whether production is actually expanding in the economy. Adjusting for price changes can resolve this.
The result, real GDP, provides a better basis for judging long-term national economic performance. For example, consider a hypothetical country which in the year 2000 had a nominal GDP of $150 billion, which fell to $100 billion by 2010. Over the same period of time, prices fell by 50%. Looking at merely nominal GDP, the economy appears to be performing poorly because nominal GDP contracted by $50 billion. However, if we adjust the 2010 nominal GDP for the price change, we can see that the 2010 GDP is worth $200 billion in 2000 dollars, so real GDP has risen by $50 billion in inflation adjusted terms.
Calculating Real GDP
GDP is derived as nominal GDP over a deflating number (R): (nominal GDP) / (R). The deflator is the measurement of inflation since the base year; dividing the nominal GDP number by the deflator removes any 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. A large difference between a nation's real and nominal GDP signifies substantial deflation (if the nominal is lower) or inflation (if the real is lower) in its economy relative to the base year of the deflator.