Real GDP

What Is Real GDP?

Real GDP can be defined as an inflation-adjusted measure that reflects the value of services and goods that are produced in a given single year by an economy which can be expressed in the prices of the base year, and that can be referred to as constant dollar GDP, or inflation corrected GDP. Below given is the formula to calculate real GDP.

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For eg:
Source: Real GDP (wallstreetmojo.com)

Analyzing the real GDP equation helps measure domestic production and the country’s economic health. This gives economists, investors, and leaders of the economy an idea of the economy’s health and the trends of the near future of the economy in question. It is a better indicator as a comparison with the base year’s GDP is possible.

What is Real GDP?

One can calculate the real gross domestic product by multiplying the nominal GDP by a deflationary number (N) or dividing the nominal GDP by the same (N).
Real GDP is a measure of the value of services and goods generated in an economy in a certain calendar year that is corrected for inflation.
Suppose there is a significant discrepancy between a country’s nominal and real gross domestic product. In that case, this indicates either a significant deflation (if the nominal is lower) or inflation (if the real is lower) in that country’s economy compared to the deflator’s base year.

Real GDP Explained

The real gross domestic product is derived as a nominal GDPNominal GDP Nominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country's population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more over or dividing the same by a deflating number (N): (nominal GDP) / (N). Compared to the base year, the deflator can be considered the measurement of inflation. Finally, dividing the nominal GDP number by this deflatorGDP Number By This Deflator The GDP deflator measures the change in the annual domestic production due to changes in price rates in the economy. Hence, it measures the change in nominal GDP and real GDP during a particular year calculated by dividing the nominal GDP with the real GDP and multiplying the resultant with 100.read more shall remove any inflation effects.

Therefore, A huge difference between a country’s nominal and the real gross domestic product shall signify a substantial deflation (in case the nominal is lower) or inflation (in case the real is lower) in its economy in comparison to the base year of the deflator.

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How To Calculate?

Real GDP Formula = Nominal GDP / Deflator

Where,

DeflatorDeflator Deflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more is a measurement of inflation

Examples

Let us understand the concept of real GDP growth with the help of a few examples and calculations.

You can download this Real GDP Formula Excel Template here – Real GDP Formula Excel Template

Example #1

Suppose an economy’s GDP is $2 million, and since the base year, the prices of the economy have increased by 1.5%. Let us use the real GDP calculator based on these estimates.

Solution

Nominal GDP: $2,000,000
Deflator Rate: $1.015

Using the above formula, let us calculate the real GDP:

= $2,000,000/ (1+1.5%)

=$2,000,000 /(1.015)

Real gross domestic product will be –

Real gross domestic product = 1,970,443.35

Hence, the real gross domestic product is $1,970,443.35

Example #2

ABC is one of the largest economies in the world. Mr. VJ has joined the statistics department which reports the country’s key statistics including gross domestic product calculation. Mr. VJ has to calculate real GDP based on the below information provided by his senior.

Private Consumption Expenditure: 1000000
Government Expenditure: 5000000
Private Domestic Expenditure: 2500000
Exports: 1500000
Imports: 9000000

Solution:

Per the above information, let us use the real GDP calculator, assuming the inflation was 2% compared to the base year. Here, we do not have a direct nominal GDP value; hence, we must first calculate the nominal GDP.

To calculate the nominal GDPCalculate The Nominal GDP The nominal GDP formula is used to figure out the nation's gross domestic product at the current price without considering inflation. It is the total of private consumption, gross investment, government investment and trade balance.read more, we need to add all the expenditures and exports and reduce imports since that was not produced.

Therefore, let us calculate the nominal GDP:

Nominal GDP = 10,00,000 + 50,00,000 + 25,00,000 + 15,00,000 – 90,00,000

Nominal GDP = 10,00,000

Let us calculate the real gross domestic product:

= 10,00,000 /(1+2.00%)

=10,00,000/(1.02)

The real gross domestic product will be –

real gross domestic product = 9,80,392.16

Hence, the real gross domestic product is 9,80,392.16

Example #3

Rico is an emerging country. Mr. Waffet is considering investing in Rico and is long in the country. However, some street analysts don’t agree with him. Mr. Waffet believes that Rico is on the verge of listing in the top 10 emerging markets as currently, it stands at 20 as per the list published. However, street analysts believe that if the real gross domestic product is more than 1 million, it can be in the top 10 list next year. One of the renowned statistics websites provides details about the country.

Rent Income: 115000
Wages Earned by Labor: 420000
Corporate Profits: 287500
Depreciation: 172500
Indirect Taxes Paid: 35000

Let’s calculate real gross domestic product, assuming that the inflation rate compared to the base year was 3%.

Solution:

Here, we don’t have the direct nominal GDP value, hence first we need to calculate the nominal GDP.

To calculate the nominal GDP, we just need to add all the income along with depreciation and indirect taxesIndirect Taxes Indirect tax, also known as consumption tax, is the type of tax the person does not directly bear. In contrast, the incidence of such taxes is passed on to the end consumer of goods or services by adding such taxes to the value of those goods or services, like Excise duty, Service tax, VAT, etc.read more since that reduces the gross income.

Therefore, Nominal GDP can be calculated as follows,

Real gross domestic product (GDP) Formula Example 3.1png

= 1,15,000 + 4,20,000 + 2,87,500 + 1,72,500 + 35,000

Nominal GDP = 10,30,000

Therefore, the calculation of real GDP can be done using the above formula:

Real gross domestic product (GDP) Formula Example 3.2png

= 10,30,000/(1+3.00%)

= 10,30,000/(1.03)

real gross domestic product will be –

Real gross domestic product (GDP) Example 3.3png

real gross domestic product = 10,00,000

Since the real gross domestic product is not more than 1 million, the country might fail to make it to the top 10 list.

Limitations

Since the nominal GDP is calculated in the monetary value of all the services and goods produced, those shall be liable to change if there is a price changePrice Change Price change in finance is the difference between the initial and final values of an asset, security, or commodity over a particular trading period.read more. For example, falling prices will lead to a decrease in the nominal GDP, and rising prices will make the nominal GDP depict as bigger or, say, larger.

But again, these changes shall not affect or depict any change in the quality or the quantity of all the services and goods being produced. Because of this, it would be difficult to answer just from the nominal GDP whether the production of the country or the economy is expanding. Amending or providing the adjustment for price changes will solve this.

The result, that is the real gross domestic product shall provide a better judgment or better basis for concluding the long-term national economic performance of the country.

Frequently Asked Questions (FAQs)

Which is higher nominal or real GDP?

While real GDP uses a GDP deflator to account for inflation and, as a result, solely shows changes in real output, nominal GDP, by definition, reflects inflation. Therefore, the nominal GDP of a nation is typically larger than the actual GDP because inflation is typically a positive number.

Why is nominal GDP less accurate than actual GDP?

Real GDP paints a more accurate picture of economic growth than nominal GDP since it accounts for inflation. It allows for meaningful year-to-year comparisons of the actual volume of goods and services produced.

What are the actual GDP’s restrictions?

The exclusion of non-market transactions is one of its significant restrictions. The absence of consideration for or representation of the severity of societal wealth disparity. The lack of information on whether or not the country’s growth rate is sustainable.

Real GDP

What Is Real GDP?

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