GDP

REAL GDP

An inflation-adjusted measure that reflects the value of all goods and services produced in a given year,
expressed in base-year prices. Often referred to as "constant-price," "inflation-corrected" GDP or
"constant dollar GDP".
Unlike nominal GDP, real GDP can account for changes in the price level, and provide a more accurate
figure.
Let's consider an example. Say in 2004, nominal GDP is $200 billion. However, due to an increase in the
level of prices from 2000 (the base year) to 2004, real GDP is actually $170 billion. The lower real GDP
reflects the price changes while nominal does not.

NOMINAL GDP

Nominal GDP is a gross domestic product (GDP) figure that has not been adjusted for inflation. Also known
as "current dollar GDP" or "chained dollar GDP."
It can be misleading when inflation is not accounted for in the GDP figure because the GDP will appear
higher than it actually is. The same concept that applies to return on investment (ROI) applies here. If you
have a 10% ROI and inflation for the year has been 3%, your real rate of return would be 7%. Similarly, if
the nominal GDP figure has shot up 8% but inflation has been 4%, the real GDP has only increased 4%.

MACROECONOMICS - NOMINAL VS. REAL GDP, AND THE GDP DEFLATOR

The main difference between nominal and real values is that real values are adjusted for inflation, while
nominal values are not. As a result, nominal GDP will often appear higher than real GDP.
Nominal values of GDP (or other income measures) from different time periods can differ due to changes
in quantities of goods and services and/or changes in general price levels. As a result, taking price levels (or
inflation) into account is necessary when determining if we are really better or worse off when making
comparisons between different time periods. Values for real GDP are adjusted for differences in prices
levels, while figures for nominal GDP are not.

THE GDP DEFLATOR

The GDP deflator is an economic metric that converts output measured at current prices into constant-
dollar GDP. This includes prices for business and government goods and services, as well as those
purchased by consumers. This calculation shows how much a change in the base year's GDP relies upon
changes in the price level.
If we wish to analyze the impact of price changes throughout an economy, then the GDP deflator is the
preferred price index. This is because it does not focus on a fixed basket of goods and services and
automatically reflects changes in consumption patterns and/or the introduction of new goods and
services.
Real GDP for a given year, in relation to a "base" year, is computed by multiplying the nominal GDP for a
given year by the ratio of the GDP price deflator in the base year to the GDP price deflator for the given
year.

EXAMPLE:

Suppose we wish to calculate the real GDP for the year 2001 in terms of 1996 dollars. The value for (note
that these values are for illustration purposes only) 1996 price deflator is 100 and the 2001 price deflator is
115. The 2001 GDP in nominal terms is $10 trillion dollars.
Then: Real GDP year 2001 in 1996 dollars =$10 trillion × (100 / 115) = $8.6 trillion

GDP AND ITS IMPORTANCE

The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's
economy. It represents the total dollar value of all goods and services produced over a specific time period
- you can think of it as the size of the economy. Usually, GDP is expressed as a comparison to the previous
quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy
has grown by 3% over the last year.
MEASURING GDP is complicated (which is why we leave it to the economists), but at its most basic, the
calculation can be done in one of two ways: either by adding up what everyone earned in a year (income
approach), or by adding up what everyone spent (expenditure method). Logically, both measures should
arrive at roughly the same total.
The income approach, which is sometimes referred to as GDP(I), is calculated by adding up total
compensation to employees, gross profits for incorporated and non incorporated firms, and taxes less
any subsidies. The expenditure method is the more common approach and is calculated by adding total
consumption, investment, government spending and net exports.
As one can imagine, economic production and growth, what GDP represents, has a large impact on nearly
everyone within that economy. For example, when the economy is healthy, you will typically see low
unemployment and wage increases as businesses demand labor to meet the growing economy. A
significant change in GDP, whether up or down, usually has a significant effect on the stock market. It's not
hard to understand why: a bad economy usually means lower profits for companies, which in turn means
lower stock prices. Investors really worry about negative GDP growth, which is one of the factors
economists use to determine whether an economy is in a recession.