If the gross domestic product is measured at prevailing market price then it is known as nominal gross domestic product and if the gross domestic product is measured at constant price or base year price then it is known as real gross domestic product. In this article, we attempt to give a brief insight into nominal GDP, real GDP, and GDP deflator.
Nominal Gross Domestic Product (Nominal GDP)
The nominal gross domestic product can be defined as the value of gross domestic product computed at the prevailing market prices of products. While measuring nominal GDP, it includes all the changes that occur in market price due to different reasons like inflation, deflation. Thus, nominal GDP involves the measurement of the monetary value of all newly produced final goods and services during a particular year by the market price of the same year. For example, if the total production of final goods and services in the year 2020 is measured in terms of market prices of 2020 then such measurement is known as nominal GDP of 2020. The major attributes of nominal GDP are listed below.
- It is GDP measured at prevailing market prices of final goods and services
- Nominal GDP reflects the monetary value of production inclusive of inflation
- It is also known as the gross domestic product at market price or unadjusted gross domestic product
- Value of nominal GDP may be increased from one year to another due to either change in price or quantity production or both
- Measurement of nominal GDP is not a better measure of the economic performance of a country. It may mislead the results.
- The ranking of world economies is based on the value of nominal GDP.
The formula to measure nominal GDP is
Nominal GDP = P1. Q1 + P2 .Q2+…+Pn.Qn
Where P1…n are respective year prices of products and Q1…. n is respective years quantities.
Real Gross Domestic Product (Real GDP)
It can be defined as the gross domestic product measured in terms of base year price or constant price. Real GDP is thus a measurement of the monetary value of domestically produced final goods and services measured at a base year’s prices. It is also known as the inflation-adjusted measurement of gross domestic product. For instance, if real GDP for 2020 is to calculate then it can be measured by measuring the final output of the year 2020 at the market price of any base year that may be 2019 or any previous year. The major attributes of Real GDP are enlisted below.
- It is GDP measured at a base year or constant prices of final goods and services
- Real GDP reflects the inflation-adjusted monetary value of production of final goods and services
- It is also recognized as the gross domestic product at base year price or constant price or inflation-adjusted GDP
- Value of real GDP increases from one year to another only due to change in quantity production
- Measurement of real GDP is a better measure of the economic performance of a country. Without an increase in the volume of real output, the value of real GDP cannot be changed and an increase in real GDP shows increased production capacity and thereby employment and living standards of an economy.
- The measurement of economic growth rate is always calculated with help of the value of real GDP.
The formula to measure real GDP is
Real GDP = P0. Q1+P0.Q2+…+P0.Qn
Where P0 is the base year price of products Q1…. n is respective years quantity produced.
It is an index that measures the relative changes in the current level of prices in comparison to the level of prices in the base year. The GDP deflator is the proportion of nominal GDP of any year to real GDP of that year times 100. The measurement of GDP deflator is mainly related to the observation of change in price in which the value of nominal GDP is determined. Therefore, the GDP deflator always measures the relative change in the price of the current year in comparison to the price level of the previous year or base year. The following formula is applied to determine the GDP deflator.
GDP Deflator = (Nominal GDP/Real GDP) ×100
With help of the GDP deflator, the rate of inflation can be measured. It implies the rate of inflation between two periods can be quantified with the assistance of the GDP deflator. The following formula is used to measure the rate of inflation between two certain times.
Rate of Inflation = (Change in GDP Deflator/Initial Value of GDP Deflator) ×100
Conclusion on Nominal GDP, Real GDP, and GDP Deflator
In this article, we have briefly explained the concept of Nominal GDP, Real GDP, and GDP Deflator. GDP measured at the current market price is nominal GDP, GDP measured at base year price is called real GDP, and the ratio between nominal GDP and real GDP of a particular time is called the GDP deflator. Nominal GDP is not a perfect measure of the performance of the economy. Real GDP is used to trace the real productivity and living standard of an economy. Given the value of nominal GDP, real GDP of different times we can measure GDP deflator and rate of inflation.