Nominal vs real GDP
What are real GDP and nominal GDP?
What is the difference between nominal and real GDP? Real and nominal GDP are two types of gross domestic product measurement that are usually used by economists.
When calculating GDP by using current market prices, we create a measure called nominal GDP. However, the prices can often change while output remains the same. Then, the measurement of output might get distorted by inflation. We account for this using real GDP.
Real GDP is a measurement of economic output that accounts for the effects of inflation or deflation. In this way, real GDP is a more accurate measure of the economy's output, providing a more realistic assessment of growth than nominal GDP. The most popular approach to finding real GDP is through the GDP deflator.
Where have you heard about real and nominal GDP?
If someone is talking about the size of an economy, they are most likely referring to real or nominal GDP. Typically, you will hear economists, politicians and news reporters use the GDP growth rate to compare the relative performance of different countries.
If reports of a country’s gross domestic product don’t specify the type of GDP, it is likely to be nominal GDP. Conversely, when economists want to emphasize monitoring of the growth of output in an economy, they will speak about real GDP in particular.
What you need to know about nominal vs real GDP.
The GDP growth rate is crucial for investors when adjusting the asset allocation in their portfolios. By comparing nations' GDP growth rates, it is easy to spot the countries with stronger growth, which, in turn, attract more investors for their corporate stocks, bonds, and even their sovereign debt.
If you are still doubting what the difference between nominal and real GDP is, we’ve got you covered.
Simply put, the nominal GDP is the value of all final services and goods produced within a country’s economy during a given period of time, typically a year. It is calculated by using current market prices of the period in which the output is produced.
In economics, a nominal GDP is expressed in monetary terms, so it can change due to shifts in both price and quantity. Therefore, if prices change and output stays the same, nominal GDP will also change, despite the output remaining constant. Falling prices will typically decrease nominal GDP and rising prices will make it look larger. Keep in mind these changes don’t necessarily reflect any changes in the quantity or quality of output produced. This is the main reason why it is difficult to tell just from nominal GDP whether the country’s production is actually expanding.
You should use nominal GDP when your other variables don't exclude for inflation. For example, you can utilise it when comparing debt to GDP, since a country's debt is also nominal.
The real GDP, on the other hand, is the total value of all final services and goods produced within a country’s economy during a given period, typically a quarter or year, accounting for both inflation and deflation. In economics, the real value is not influenced by changes in price but only impacted by changes in quantity. It is calculated using the prices of a selected base year to remove any effects of inflation. Real GDP transforms nominal GDP, a money-value measure, into an index for quantity of total output.
Real GDP can be used to determine whether the country’s economy is growing slower or faster compared to the quarter or year before. In this way, it is easy to define where the economy is in the business cycle. Real GDP is often used to compare the size of economies throughout the world.