Real GDP

What is Real GDP?

Real GDP can be defined as an inflation-adjusted measure which shall reflect 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”, “inflation corrected GDP”. Below given is the formula to calculate real GDP.

Real GDP Formula

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

Where,

• DeflatorDeflatorDeflation is a decrease in the prices of goods and services caused by negative inflation (below 0%). It usually results in increased consumer purchasing power, owing to a simple supply and demand rule in which excess supply leads to lower prices.read more is a measurement of inflation

Explanation

The real gross domestic product can be derived as a nominal GDPNominal GDPNominal 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). Comparing to the base year, the deflator can be considered as the measurement of inflation; and finally, when dividing the nominal GDP number by this deflator this shall remove any inflation effects.

A large difference or 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 when compared to the base year of the deflator.

Examples

Example #1

Suppose that the economy’s GDP is $2 million and since the base year, the prices of the economy have increased by 1.5%. You are required to calculate real GDP based on these estimates.

Solution

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

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

= $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 been asked to calculate real GDP based on below information provided by his senior.

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

Solution:

Based on the above information, you are required to calculate real GDP, assuming the inflation was 2% compared to the base year. Here, we are not given direct nominal GDP value, hence first we need to calculate the nominal GDP.

To calculate the nominal GDPCalculate The Nominal GDPThe 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 just need to add all the expenditures along with export and reduce import since that was not produced in the economy.

Therefore, the nominal GDP calculation can be done as follows

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

Nominal GDP = 10,00,000

Therefore, the calculation of real gross domestic product can be done using the above formula as,

=  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 of the street analysts somehow don’t agree with Mr. Waffet. Mr. Waffet is of the view that Rico is on verge of listing in the top 10 emerging markets as currently, it stands at 20 as per the list published. The street analysts are of the view that if the real gross domestic product is more than 1 million then it can make 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

You are required to calculate real gross domestic product, assuming that the inflation rate compared to the base year was 3%.

Solution:

Here, we are not given 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 taxes since that reduces the gross income.

Therefore, Nominal GDP can be calculated as follows,

= 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 as,

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

= 10,30,000/(1.03)

real gross domestic product will be – 

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.

Relevance and Uses

Because the nominal GDP is calculated in the monetary value of all the services and goods that are produced, those shall be liable to change in case there is a price change. For example, in case of falling prices that will lead to a decrease in the nominal GDP and on the other side in case of rising prices, it 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 that are being produced. And because of which, it would be difficult to answer just from the nominal GDP whether the production of the country or of the economy is in fact expanding. Amending or providing the adjustment for changes in price will be able to 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.

Recommended Articles

This has been a Guide Real GDP and its definition. Here we discuss the formula to calculate real gross domestic product (GDP) along with practical examples. You can learn more about financial analysis from the following articles –

• Dollar-Cost Averaging
• Formula of GDP
• Nominal GDP vs Real GDP
• Lagging Indicators