What is Real GDP?
Real GDP (Gross Domestic Product) doesn’t calculate the GDP at a current market price. It takes the price of a base year and then calculates the quantities produced of the current year and then multiply the two to find out the GDP. Nominal Gross Domestic Product is the sum-total of all the goods, finished products, services produced during a particular year after taking inflation into account.
Real Gross Domestic Product of the US increased to 2.3% in 2017 as compared to an increase of 1.5% in 2016.
Real GDP Calculation
Below example, we took in our article on nominal GDP
- Let’s say that a country named “T” produces 1000 kilograms of mangoes in 2015. The price per kilogram is $10. That means, in 2015, the Nominal Gross Domestic Product is $10,000.
- Similarly, we will look at the GDP of the country “T” in the year 2016. In 2016, country “T” produces 1300 kilograms of mangoes. And the price increased to $13 per kilogram. That means, in 2016, the Nominal Gross Domestic Product is $16,900.
From the above example, we got that the Nominal Gross Domestic Product of 2015 and 2016 were $10,000 and $16,900.
But now we will do something different. We will take the price of 2015 as the base price and then look at the quantity of 2016 and then we will try to compare the results of 2015 and 2016.
- In 2015, the price of mangoes per kilogram was $10.
- And in 2016, the mangoes produced were 1300 kilograms.
- So, the real Gross Domestic Product would be = (1300 * $10) = $13,000.
Now, we can compare the results between 2015 and 2016.
- In 2015, the GDP was $10,000 and in 2016 (by following the real Gross Domestic Product), the Gross Domestic Product was $13,000. That means, the productivity of country “T” has increased by = ($13,000 – $10,000) = $3,000.
Also, have a look at this article – Nominal vs Real GDP
What is GDP Deflator?
Understanding this is important if you want to find the real Gross Domestic Product. Since the nominal Gross Domestic Product is the current market price of the quantities produced and real Gross Domestic Product assumes the price of a base year, we need to deflate the price that is being inflated to find out the real GDP. And that is called GDP deflator.
Let’s take a simple example to illustrate this.
Let’s say that the price of all the goods and services is $1000 in 2015 and $1200 in 2016. In reality, finding out the price isn’t easy, because there will be an increase/decrease in price or quantity; thus, things are much complex in real life. But for the sake of simplicity, let’s say that the above price points are true. Now, we can see that the inflation in price from 2015 to 2016 is $200/$1000 * 100 = 20%.
To find out the real GDP, we need to see how GDP deflator works. In this example, we will express find out the GDP deflator in the following manner –
- Nominal GDP / Real GDP = $1200 / $1000
- Or, Nominal GDP = Real Gross Domestic Product * ($1200 / $1000)
- Or, Nominal GDP / ($1200 / $1000) = Real Gross Domestic Product
- That means, to find out the real Gross Domestic Product, we need to divide the nominal GDP by 1.2.
Advantages of Real GDP
The advantages of Real Gross Domestic Product are the following –
- It can compare the result of two financial years: Since Real Gross Domestic Product takes inflation into account and the calculation is based on a base year, it’s easier to compare the performances of two years.
- It is the favorite method of calculation for economists and experts: Real Gross Domestic Product is popular among economists and experts because it goes deep into the price, quantity produced, and the effect of inflation.
Disadvantage of Real GDP
The only disadvantage of real GDP is its complexity. It is not easy to calculate real Gross Domestic Product. To calculate the Real Gross Domestic Product, one has to take the market price of the base year into account. Plus, you need to pay heed to the quantity produced of the current year. And you need to pay attention to inflation as well. That’s why a layman doesn’t go for the calculation of real GDP; rather s/he opts for nominal GDP which is easy to ascertain.
This has been a guide to What is Real GDP, Real gross domestic product calculation, GDP Deflator, along with its advantages and disadvantages. You may also have a look at these articles below to learn more.