Real GDP vs. Nominal GDP

When discussing the economy wide concept of Gross Domestic Product (GDP) you will often see reference to real GDP and nominal GDP. Understanding the difference between these two is important as they reflect different factors and comparing them directly, say one countries nominal GDP and another's real GDP, would provide little value.
This article will help you clearly differentiate between the two and understand what's meant by real GDP vs. nominal GDP.

Nominal GDP

When referring to simply GDP most often what is being discussed is the nominal GDP of a country. GDP is an estimate of the total value of a country's production and services, calculated over a one year time period.  It is typically calculated as:

GDP = Consumption + Investment + Government Spending + (Exports – Imports)

It is always important to look at the actual methodology used though as often different institutions or organizations may utilize modified versions to arrive at what they consider GDP. As GDP is built on estimate after estimate it is a very rough approximation of a countries productive power, and omits many things like the ‘grey' or outright illegal economy. In some countries this is a minor omission but in others it can significantly impact the total GDP.

For comparative purposes, the per capita GDP is also commonly calculated, dividing GDP by the population, to see what the comparative value of production is for every individual. This is important because in extreme examples where based on nominal GDP India ranked 10th in global GDP at $1.87 trillion and Canada ranked 11th at $1.72 trillion. However when you look at GDP per capita Canada ranks 10th at $52K and India ranks 142nd at $1.5K, a stark difference because of India having 34 times as many people as Canada.

Real GDP

Real GDP provides further insight in that it adjusts nominal GDP for the impact of inflation over a set time period. To calculate real GDP a ‘base year' is chosen and then inflation from that year forward will be considered to determine the actual growth in GDP after adjusting for inflation. This is important to consider because in pure dollar numbers GDP will almost always be increasing, but when you consider inflation a lot of that growth will be taken away.

This reflects the true ‘purchasing power' or value of GDP (compared to the base year) and the impact varies from country to country as inflation rates can be very different. If for example a country has 10% GDP growth but 9% inflation, their real growth is only about 1% while the rest is due to factors like more money being printed. Comparatively a country could have 6% for GDP growth but only 2% inflation, so their actual growth was 4%.

Real GDP rates will be lower than nominal GDP for any countries experiencing inflation, which is the vast majority of countries, and for many analysts is a far more useful number in terms of correctly reflecting a countries growth in value.
By Jeffrey Glen

Copyrighted 2020. Content published with author's permission.

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