What is Real GDP?
Definition: Real GDP (Gross Domestic Product) is an economic measurement that calculated the a country’s economic output adjusted for inflation.
Gross Domestic Product (GDP) is the term that describes a country’s economic output or in simpler terms, the goods and services that are generated within a country over a specified duration of time.
Real GDP takes things a notch higher by not just evaluating the economic output but also considering inflationary and deflationary effects in an economy. This allows it to provide a more accurate outlook of the economy compared to nominal GDP, which only focuses on growth and prices. Nominal GDP is still important because it is included when calculating the value of real GDP in an economy.
Real GDP Formula Calculation
Calculating the real GDP value in an economy makes use of the formula R = N/D, where N represents the nominal GDP while D represents the GDP deflator value.
GDP is calculated using the formula GDP=C+I+G+(X−M) which is an oversimplification of the formula;
GDP = private consumption + gross investment + government investment + government spending + (exports – imports).
Calculating real GDP takes into account the changes in the GDP from the base year, and it is then divided by the level of inflation from each year. This means that real GDP considers that nominal GDP would change even if there are price changes without output changes.
The GDP deflator is a price index that determines the level of inflation or deflation in an economy, thus a representation of price inflation. It can be represented as a ratio of nominal GDP relative to real GDP. Below is the equation for calculating the GDP deflator.
Nominal GDP vs Real GDP – What’s the Difference?
There are slight differences between real GDP and nominal GDP. The latter only factors in the commodities and services produced within an economy in a particular year.
Meanwhile, real GDP goes the extra mile by considering inflationary effects. Below is a chart comparing the real GDP and nominal GDP of the U.S between 2012 and 2018.
Real GDP as a measure of services
Real GDP is also applied when measuring services, and it evaluates a wide range of services such as banking services, military services and even things like hairdressing services and services provided by non-profit organizations. It also accounts for mundane services such as those that people access at the comfort of their own homes, and this includes services like housekeeping.
Unfortunately, not all services are easy to measure, and so some of them might not be included. For example, measuring black market activities, housework, elder care, and unpaid child care is quite difficult. It is therefore not easy to get the exact figures, but economics come up with rough estimates that account for major economic activities in a country when calculating real GDP.
Real GDP as a measure of growth
Real GDP is a vital tool when calculating economic growth. GDP growth rate is real GDP’s percentage change. Using real GDP is important because it helps to calculate real growth. This means that real GDP can be used to identify whether the economic growth rate is faster or slower than it was in the previous quarter.
Economists believe that the best range for the GDP growth rate is between 2% and 3%. The Bureau of Economic Analysis in the U.S. The BEA conducts a quarterly review of the growth rate so that it can adjust based on new data that it receives every month. The GDP growth rate is a vital tool for investors because it helps them to make investment decisions, especially those regarding how to allocate resources in their investment portfolios.
Investors can also compare the GDP growth rates of multiple countries so that they can identify which countries are doing better than others. This helps investors to make decisions on where to invest their money. Countries that experience high GDP growth rates tend to offer a lot of investment opportunities, and this is why investors find them attractive.