Introduction
GDP or Gross Domestic Product is defined as an economic estimate of the market price of all the final goods and services manufactured and merchandized in a specific time by a country. GDP is defined as the measure of the financial value of all goods and services produced in a country for a definite period. The period is generally annual, but GDP may be calculated quarterly at times. GDP is made to be used by the government of a nation to gauge its economic condition. This method is checked thoroughly before being regarded as a dependable indicator because of its subjective and complex nature. GDP can be used as a metric for international comparisons and a broad measure of economic progress.
GDP can be estimated using three methods Income, Production and Speculated expenditure approaches. The production approach is the direct way which sums the outputs of every status of corporations to arrive at the total. The speculated expenditure approach states that every product is ought to be bought by someone. Therefore, the value of the total product must be equal to people's total expenditures in buying things. The production method works on the norm that the earning of the producers must be equivalent to the rate of their product.
There are four types of GDP-
- Real GDP- Thisis the type of calculation of GDP that has been modified for inflation.
- Actual GDP- Actual GDP is the measurement of a country's economy at the current time.
- Potential GDP- It is the estimation of a country's economy under immaculate conditions like low inflation, full employment, etc.
- Nominal GDP- Nominal GDP is estimated with inflation. The costs of products are calculated at current price levels.
Real GDP vs Nominal GDP
Nominal GDP and Real GDP are considered monetary metrics for assessing the nation's economic growth and development. How they are different, is the question?
The economic value of all goods and services produced in a given year, revised according to - alterations in the market price status, is known as Real Gross Domestic Product. On the other hand, Nominal Gross Domestic Product refers to the monetary worth of all goods and services produced during the year within the geographical limitations of the country.
Real GDP delivers a more exact measure of economic development over time because it modifies itself according to general price-level transformations. Nominal GDP may show an increase in economic growth but, it could be due to a rise in prices rather than an actual upsurge in production.
We will discuss the difference between Real GDP and Nominal GDP further in detail.
Difference Between Real GDP and Nominal GDP in Tabular Form
| Parameters of Comparison | Real GDP | Nominal GDP |
| Definition | Real GDP or Real Gross Domestic Product is the total value of a country’s goods and services in a given period, adjusted for inflation. | Nominal GDP or Nominal Gross Domestic Product is the total value of goods and services a country produces in a given period, estimated at current market prices. |
| Basis | Real Gross Domestic Product is calculated based on the base year’s market value. | Nominal GDP is calculated based on the current market values of goods and services produced. |
| Nature of Complexity | Calculating Real Gross Domestic Product can be a little complicated. | The calculation of Nominal Gross Domestic product is relatively easier. |
| Inflation effect | Real GDP takes Inflation into consideration. | Nominal Gross Product does not contemplate inflation. |
| Comparison | Comparisons can be made with previous financial years in Real GDP process. | In Nominal GDP, comparisons can be done between previous GDPs. |
| Economic growth | Economic growth can be easily analysed using Real GDP. | Nominal GDP is not a good indicator of economic growth as it does not consider inflation. |
| Expression | Real GDP is expressed in terms of Base year’s prices of products. | It is expressed in terms of current year’s values of products and services. |
What is Real GDP?
The Real Gross Domestic Product, or Real GDP growth rate, measures economic growth, from a particular duration to another, revised for inflation or deflation. In simple words, it shows transformations in the worth of all goods and services produced by an economy (the economic output of a country) while accounting for expenditure fluctuations. Economists favour Real GDP over other estimations because it adjusts for price modifications, presenting a more accurate view of production growth.
While calculating Real GDP estimation is done at specified prices, i.e. at the prices which are prevailing at some point time in the past, known as base year price or reference price. It reflects the economic output at constant prices. Real GDP can be taken as a fair indicator of a nation’s monetary growth because it solely considers production and is free from price changes or currency oscillations. To understand better, you should have a look at some of the features of Real GDP.
Salient Features of Real GDP
- Real GDP is used by policymakers for determining growth over time by comparing GDP from distinct periods.
- The Real Economic Growth Rate represents itself as a percentage that showcases the speed of evolution in a country's GDP, typically from one year to the following year.
- The Real GDP figure helps to compare the current pace of economic growth with previous periods to establish the general trend in evolution over time.
- It has a massive impact on the government. When the GDP growth rate is slowing down or raising too fast, a government and its central bank, needs to take action to rectify the trend. These processes influence investors and individuals correspondingly.
- Stock markets also respond to the quarterly publishing of Real GDP numbers. As GDP is a calculation of the soundness of the economy, and the stock market's moves include presumptions about the future, positive or negative Real GDP numbers will drive the markets in the corresponding path.
- Although the Real GDP figures don't impact the individuals directly, the policymakers' reactions do. For instance- If the central bank reduces the interest rates to combat contracting GDP, it is a good time for people to take on debt when the outlay of borrowing is more affordable.
- The real GDP is beneficial when comparing the transition rates of similar economies that have substantially separate rates of inflation.
How to Calculate Real GDP
Firstly, GDP is the sum of consumer expenditure, business spending, government spending, and total exports, minus total imports.
Real GDP=Nominal GDP ∙ GDPbase year GDPcurrent year
The base year is a designated year, updated periodically by the government and utilised as a comparison point for economic data.
What is Nominal GDP?
Nominal gross domestic product (GDP) refers to the GDP evaluated at current market prices. It is the total value of all goods and services constructed in a given period less than the price of those created during the production process. A country's nominal GDP estimates the economic production in its economy including the current rates of goods and services in its estimation.
The Nominal Gross Domestic Product of two successive years allows us to assess the year that has been more efficient for the country. However, economists have a distinct way of decoding the figures. They go deep into the productivity of the nation. The Nominal GDP is essential as it reflects a country’s product quantity. The current market prices are also taken into consideration, which indicates the market’s current price tendency. In simple words, when computed, this GDP allows analysts comprehend the exact figures and evaluate the difference between the total and Real Gross Domestic Products. The following salient features will make you understand Nominal GDP better.
Salient Features of Nominal GDP
- Budding Nominal GDP from year to year may reflect an improvement in prices as contradictory to growth in the number of goods and services made.
- The economy is a sequence of interrelated procedures that specify the allocation of resources. The processes include the production, consumption of goods and services, and distribution, along with other activities. These goods and services are needed by those living within the economy.
- While some costs can be measured, Nominal GDP doesn't comprise external expenditures that are crucial to the production process, such as waste and environmental factors.
- Talking about production, Nominal GDP considers only the final production rather than the methods and parts used during the manufacturing procedure.
- Nominal GDP doesn't comprise valuable services that contribute to society and the economy as a whole, because they can't be expressed in quantity. For example- unpaid internships and volunteer work.
- It is easy to know the current market price, and the number of products produced during the year can also be assembled easily. Therefore it is easier to perform a calculation using the Nominal GDP equation.
- Nominal GDP accounts for the current market costs. The total value of the goods and products constructed in a country is estimated considering the same.
- It is necessary to keep in mind that Nominal GDP is not modified to account for inflation but is simply a calculation of the number of goods multiplied by their current prices.
How to Calculate Nominal GDP
Nominal GDP is estimated using the formula given -
GDP=Private consumption+Gross investment+Govt. investment+(Exports -Imports)
- The expenditure method explains the alterations in capacity and the current market prices and it's an appropriate way to calculate Nominal GDP.
- The GDP deflator approach makes use of the Real GDP level and the change in price in its calculation. When multiplying the two components, the outcome that we get is the Nominal GDP.
Main Differences Between Real GDP and Nominal GDP (In Points)
- Nominal GDP is the financial worth of services and goods that get produced within the country. It is based on the price of the goods and services of the current year. Real GDP is the financial value of all goods and services yielded within the boundaries of a country. It is established on the price of the goods and services of the base year.
- Real GDP is the inflation-revised GDP of a nation. Inflation affects Real GDP. Nominal GDP is the Gross Domestic Product without any impact of inflation.
- Real GDP delivers a more accurate measure of economic development over time because it modifies itself according to general price-level transformations. Nominal GDP may show an increase in economic growth but, it could be due to a rise in prices rather than an actual upsurge in production.
- Nominal GDP is commonly used for international comparisons as it reflects the current market prices of products. Real GDP is a more accurate measure of economic performance because it accommodates inflation.
- In Real GDP, a comparison of varied financial years may be drawn out easily because by dismissing the value of inflation, the comparison is made only between the outcomes produced. Whereas, with Nominal GDP, one can equate diverse quarters of the same financial year.
- Nominal GDP is not a good indicator of economic growth. On the contrary, Real Gross Domestic Product can analyze economic growth.
- The value of Nominal GDP is higher than the worth of Real GDP because, during the calculation, the estimate of inflation is deducted from the total GDP.
Conclusion
Let's summarise the article.
The worth of all the final goods and services produced by an economy during a particular year is known as Nominal GDP, calculated by the current year's outlay in which the output has got produced. The market value of goods and services produced in an economy without considering inflation is a Nominal GDP.
Real Gross Domestic Product/ Real GDP elucidates the modifications in rates because of inflation. Thus, it can be concluded that Real GDP is different in this aspect i.e. inflation adjustment. Therefore, in a specific financial year, if the price of production alters with the change in time, while the output remains untouched, then the value of Real GDP will stay the same.
Nominal GDP and Real GDP are vital economic indicators that help policymakers and economists examine and scrutinise an economy’s performance. This article has tried to cover every aspect of Real GDP as well as Nominal GDP, from their definitions to their differences.
References
- https://en.wikipedia.org/wiki/Real_gross_domestic_product
- https://www.wallstreetmojo.com/nominal-gdp/
- https://www.masterclass.com/articles/what-is-gdp
