Difference between Nominal GDP and Real GDP

Nominal GDP and Real GDP are essential for evaluating economic health, making policy decisions, and conducting economic comparisons. Nominal Gross Domestic Product (GDP) measures the total value of all goods and services produced in an economy over a specific period (usually a year or a quarter) using current prices. Real Gross Domestic Product (GDP) measures the total value of all goods and services produced in an economy over a specific period, adjusted for inflation or deflation, using constant prices from a base year.

Nominal GDP is the Gross Domestic Product of a country of a given year, estimated on the basis of the price of the goods and services of the same year. The formula for determining the Nominal GDP of a country is,

[Tex]Nominal~GDP=\frac{Real~GDP\times{Price~Index}}{100}[/Tex]

Characteristics of Nominal GDP

1. Current Prices: It measures the value of output using the prices that are current in the year in which the output is produced.
2. No Adjustment for Inflation: It does not account for changes in the price level. Thus, it can give a misleading sense of growth if prices have increased significantly.
3. Economic Comparisons: It is useful for comparing the economic output of different countries at a given time using current exchange rates.
4. Representation: It often reflects the “face value” of the economic performance, making it useful for short-term economic assessments.

Real GDP is the Gross Domestic Product of a country of a given year, estimated on the basis of the price of the goods and services of a base year. The formula for determining the Real GDP of a country is,

[Tex]Real~GDP=\frac{Nominal~GDP}{Price~Index}\times{100}[/Tex]

Characteristics of Real GDP:

1. Constant Prices: It measures the value of output using prices from a base year, which helps in eliminating the effects of price changes.
2. Adjustment for Inflation: By accounting for changes in the price level, real GDP offers a clearer view of an economy’s true growth.
3. Economic Comparisons Over Time: It is useful for comparing the economic output of the same country across different years, making it a better indicator of economic health and growth trends.
4. Standard of Living: Real GDP per capita (GDP divided by the population) is often used to gauge the standard of living and well-being of a country’s citizens.

The Real GDP of a country can be more, equal, and less than its Nominal GDP. 

Real GDP > Nominal GDP: When the price level of goods and services in the base year is more than the price level of goods and services in the current year. 

Real GDP = Nominal GDP: When the price level of goods and services in the base year is the same as the price level of goods and services in the current year.

Real GDP < Nominal GDP: When the price level of goods and services in the base year is less than the price level of goods and services in the current year. 

Also Read:

• National Income and Related Aggregates
• GDP Deflator | Meaning and Formula
• GDP and Welfare

Real GDP is better than Nominal GDP because of the following reasons:

1. Helps in the determination of the effect of increased production

Real GDP helps an economy to determine the effect of increased production levels of goods and services within a year. Real GDP is better for this determination because even though there is no change in the physical or actual production of goods and services, a change in their price affects the value of Nominal GDP. 

2. Better Periodic Comparison 

Real GDP is better than Nominal GDP for making a periodic comparison in the production of physical output of goods and services of a country over different years. 

3. Facilitates International Comparison

The Real GDP of an economy also facilitates a better international comparison of the economic performance across the countries. 

What is Nominal GDP?

Nominal GDP, or Gross Domestic Product at current prices, measures the total value of all goods and services produced in an economy during a specific period, using current prices without adjusting for inflation.

How is Nominal GDP calculated?

Nominal GDP is calculated by summing the current prices of all final goods and services produced in an economy within a specific time frame, typically a year or a quarter.

[Tex]Nominal~GDP=\frac{Real~GDP\times{Price~Index}}{100}[/Tex]

What is Real GDP?

Real GDP measures the total value of all goods and services produced in an economy during a specific period, adjusted for inflation. It reflects the true volume of production and allows for comparisons over time.

How is Real GDP calculated?

Real GDP is calculated by adjusting Nominal GDP for inflation using a price index, such as the GDP deflator. The formula is:

[Tex]Real~GDP=\frac{Nominal~GDP}{Price~Index}\times{100}[/Tex]

How do inflation and deflation affect Nominal GDP and Real GDP?

Inflation increases the price level, which can cause Nominal GDP to rise even if the actual output remains the same. Deflation decreases the price level, potentially lowering Nominal GDP. Real GDP, however, adjusts for these changes in price levels, reflecting the true output.

What is the GDP deflator?

The GDP deflator is a price index that measures the average change in prices of all goods and services included in GDP. It is used to adjust Nominal GDP to obtain Real GDP.

Can Nominal GDP ever be lower than Real GDP?

Nominal GDP is typically higher than Real GDP during periods of inflation. However, during periods of deflation, Nominal GDP could be lower than Real GDP.

How do changes in population affect Nominal GDP and Real GDP?

Changes in population can affect both Nominal and Real GDP. An increasing population might lead to higher overall GDP due to more workers and consumers. However, to understand the standard of living, GDP per capita (GDP divided by population) is often used.