Real Gross Domestic Product (Real GDP) is a modification of the basic Gross Domestic Product (GDP) calculation that is commonly used to measure the size and growth of a country’s economy. Real GDP involves modifying the normal GDP figure to account for inflation and remove the impact that it has on GDP growth over time.
While Real GDP is itself a useful number calculated to reflect the value of a country’s economy it is far more insightful to assess GDP over time and see how a country’s economy is growing (or contracting) over time. For reference typically GDP is calculated as:
- GDP = Consumption + Investment + Government Spending + Exports – Imports
To factor inflation into Real GDP the following formula is then typically used:
- Real GDP = GDP / (1 + Inflation since base year)
Calculating the Real GDP Growth Rate
Calculating the Real GDP growth rate is fairly straightforward after the GDP and Real GDP figures are available. It’s important to note that the complexity and work required to accumulate information also means that calculating GDP (or Real GDP) personally is nearly impossible, so you will have to rely on an organization that publishes the data. Calculating the 2014 Real GDP growth rate would be done as follows:
- 2014 Real GDP Growth Rate = (2014 Real GDP – 2013 Real GDP) / 2013 Real GDP
This will provide the Real GDP growth rate, expressed as a percentage, for the 2014 year. This figure can then be compared to the Real GDP growth rates of prior years (calculated the same way) or to that of other countries. The comparison of Real GDP growth rates can be incredibly useful to see how a country itself is trending over several years (getting better or worse) or to see how in absolute terms the country’s growth compares to that of comparable economies.
Calculating a quarterly Real GDP growth rate is also straight forward. The quarterly Real GDP growth rate would be calculated as follows:
- 2014 Q2 Real GDP Growth Rate = (2014 Q2 Real GDP – 2014 Q1 Real GDP) / 2014 Q1 Real GDP
This will provide the Real GDP growth rate percentage for Q2 of 2014 alone. Once the figures for each quarter in 2014 have been prepared you can add them all together to arrive at the 2014 Real GDP growth rate (or follow the annual process indicated above).
Importance of Using Real GDP Growth Rates
Inflation can have a significant impact on the dollar value of a country’s economy and adjusting GDP to use Real GDP provides far more insight in terms of what the true growth has been and the true change in the country’s purchasing power. Accounting for inflation when comparing growth rates across countries becomes even more important when you consider that different countries experience different inflation rates over time. A country with a 7% inflation rate will see far more of their GDP’s dollar value removed by using a Real GDP figure than a country with 1% inflation over the same period. By using Real GDP you get a clearer picture in terms of the actual purchasing power improvement of the individual countries economies.