Is Real Gdp or Gdp Used to Calculate Economic Growth

When measuring economic growth, economists typically use Real GDP rather than nominal GDP. This article explains why Real GDP provides a more accurate measure of economic performance by adjusting for inflation.

GDP vs. Real GDP

Gross Domestic Product (GDP) is a monetary measure of the market value of all final goods and services produced in a country in a given period. It's calculated using current market prices (nominal GDP) or constant prices adjusted for inflation (Real GDP).

Nominal GDP = Sum of all final goods and services produced in a country, valued at current prices.

Real GDP = Nominal GDP adjusted for inflation to reflect the actual volume of production.

The key difference is that nominal GDP can be distorted by inflation, making it appear that the economy is growing when it's really just prices rising. Real GDP removes this distortion by comparing current production to a base year's production.

Why Use Real GDP for Growth

Economists prefer Real GDP for measuring economic growth because:

Inflation adjustment: Removes the effect of rising prices, showing actual production growth.
Comparability: Allows comparison between different years and countries.
Policy evaluation: Provides a clearer picture of economic performance for policy decisions.

While nominal GDP shows the total value of production, Real GDP shows the actual quantity of goods and services produced. This makes it the preferred measure for tracking economic growth over time.

Real GDP growth is calculated as the percentage change in Real GDP from one period to another. For example, if Real GDP grows by 3% in a year, it means production has increased by 3% after accounting for inflation.

Calculating Real GDP

The formula for Real GDP is:

Real GDP = (Nominal GDP / GDP Deflator) × 100

Where GDP Deflator = (Nominal GDP / Real GDP) × 100

The GDP Deflator is a measure of price changes in the economy. By dividing nominal GDP by the GDP Deflator, we get Real GDP, which reflects the actual quantity of production.

For example, if nominal GDP is $2 trillion and the GDP Deflator is 110, then Real GDP would be:

Real GDP = ($2 trillion / 110) × 100 = $1.818 trillion

Worked Example

Let's look at a concrete example to illustrate the difference between nominal and real GDP growth.

Year	Nominal GDP (Billions)	GDP Deflator	Real GDP (Billions)	Nominal Growth	Real Growth
2020	1,000	100	1,000	-	-
2021	1,200	110	1,090.91	20%	9.09%
2022	1,440	120	1,200	20%	10%

In this example, nominal GDP shows 20% growth each year, but real GDP growth is only 9.09% and 10% respectively. This shows how inflation can distort the perception of economic growth when using nominal GDP.

Frequently Asked Questions

Why is Real GDP better than nominal GDP for measuring growth?

Real GDP adjusts for inflation, providing a more accurate measure of the actual production of goods and services. This makes it better for comparing economic performance over time and between countries.

How is the GDP Deflator calculated?

The GDP Deflator is calculated by dividing nominal GDP by real GDP and multiplying by 100. It measures the average price level of all new goods and services produced in the economy.

Can Real GDP be negative?

Yes, Real GDP can be negative if the economy is in a severe recession and production falls below the base year's level. This is a more accurate reflection of economic conditions than nominal GDP.

What's the difference between GDP and GNP?

GDP measures the total output of a country's economy, while GNP measures the income of all residents of a country, regardless of where they live. GNP is typically smaller than GDP because it excludes income from foreign-owned assets.