The nominal gross domestic product is the total market value of all newly produced goods and services during each time, usually annually. Real GDP is nominal GDP adjusted for inflation or measurement of newly-produced goods and services at constant prices. Real GDP is used to measure the actual growth of production without any effects of inflation. Economists believe that real GDP is better than nominal GDP because of the following reasons (Among Nominal GDP and Real GDP, which GDP is better?).
It is always significant to identify the total quantity that the economy has produced and consumed over time. Real GDP is a key indicator for the measurement of the overall health and growth of the economy by measuring the real consumption capacity of stakeholders. Thus, it is used to determine economic policy going forward.
Real GDP offers a better measure than nominal GDP while measuring the status of economic output in the real sense. It means whether the output has increased or not over time is correctly estimated by real GDP.
The growth rate of real GDP shows the actual rate of economic progress based on which policies can be formulated. For instance, in any nation, the central bank can reduce interest rates if there is a lower rate of growth in real GDP.
When there is a rise in the value of the GDP of a nation, it does not necessarily signify that the country has produced much output. To identify this, it is necessary to specify whether we are mentioning nominal GDP or real GDP. An increase in nominal GDP may just infer prices have increased or an increase in nominal GDP may be only because of an increase in prices but an increase in real GDP means output has increased or real GDP increases only when output increases.
Real GDP is therefore key to exhibiting the real or realized economic situation of the nation and to providing bases for the policy formulation rather than nominal GDP. Nominal GDP in a nation could increase because of an increase in prices of products only but real GDP to increase requires output to increase, thus, real GDP shows the growth of the economy in a real sense than nominal GDP. This can be further analyzed with help of the following table.
Thus, to show the actual or real economic health of the nation and to provide bases for the policy formulation, real GDP plays a significant role and can be analyzed with help of the following hypothetical situation.
| Year (1) | Output (2) | Price (3) | Nominal GDP (2*3) | Nominal GDP Growth Rate | Real GDP (2016 Base) | Real GDP Growth Rate | Attributes |
| 2016 | 10 | 2 | 20 | – | 20 | – | |
| 2017 | 15 | 3 | 45 | 100% | 30 | 50% | |
| 2018 | 15 | 5 | 75 | 66.67% | 30 | 0% | There is no real growth in the economy |
| 2019 | 13 | 8 | 104 | 38.67% | 26 | -15.38% | The economy suffers from negative growth and needs special treatment |
| 2020 | 18 | 11 | 198 | 90.38% | 36 | 38.46% |
Looking at the nominal GDP in 2018, the size of the economy has increased by about 67 percent, but looking at the real GDP, the real product has increased by zero rates. Similarly, in 2019, only real GDP has shown the reality of the economy. Therefore, when formulating a policy based on nominal GDP, there is a danger that the economy will go in the wrong direction. It means only real GDP shows the actual situation of an economy for better policy formulation.