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What Is the Difference between Real GDP and Nominal GDP?
Gross Domestic Product (GDP) involves a calculation of the total value of the goods and services generated within an economy in a stated or identified time period. The main difference between real GDP and nominal GDP is that nominal GDP does not consider how inflation or deflation affects the price of goods over time. In contrast, real GDP involves a calculation of the increase in price that is the consequence of inflation or deflation in the economy.
Real GDP and nominal GDP are separated only by the consideration of price increments due to inflation. Usually, GDP is measured periodically at the end of specified business cycles. The business cycle or the period under consideration is usually quarterly. At the end of each quarter, economists calculate the aggregate price level of goods and services for that period in order to arrive at a figure that is used as a basis for comparison to other business cycles. The result of this figure will tell the economists or other interested parties a lot about the state of the economy, which is usually where the real GDP and nominal GDP are separated.
An increase in the general price for the period under consideration indicates that there has been a change in the dynamics of the laws of demand and supply. This usually points to an inflationary increase in the demand for the goods and services by consumers leading to an increase in price level. Other factors that may cause an increase in price levels is an increase in the price of goods and services by companies in order to compensate for shortfalls in their profits. A market that is substantially monopolistic may also contribute to price increases through the actions of arbitrary price increases by organizations that lack the steadying influence of a competitive marketplace.
Real GDP and nominal GDP give different results to those who are calculating the statistics of the total value of goods. Economists use the nominal GDP to find out the general price of the goods and services for the period without taking any other effect into consideration. They do not rely on this result alone though, because it would be higher than that of the real GDP. The real GDP is usually adjusted by taking into consideration the effects of inflation and making adequate adjustments to reflect the difference in value. As such, the result of the real GDP is often lower than the result of the nominal GDP.
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Discussion Comments
@SarahGen-- Just to clarify, for nominal GDP, a base year is selected for the price whereas in real GDP the prices for the current year are used (hence inflation and deflation). So real GDP gives a more relevant picture of the economy.
@ZipLine-- I'm not an economy expert but I think that real GDP is mostly used to measure changes in productivity. It gives us a better idea about how economic output is changing. Real GDP might not be adjusted for inflation, but it is adjusted for prices.
I wouldn't say that real GDP is a better measurement tool than nominal GDP nor would I say that it's enough to judge an economy. I think real GDP and nominal GDP are both valuable measurements, they just measure different things.
So real GDP is a better measure of how the economy is doing, just like its name suggests?
Aren't inflation rates very important in judging the state of an economy? So why do we need to look at nominal GDP at all?
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