Nominal & Real GDP (2 GDP Measures)

 WHAT IS GDP?

Gross domestic product (GDP) is the value of all final goods and services produced within a country in each year, i.e. the geographic area of the country.

Nominal GDP vs Real GDP

Introduction

Understanding Nominal & Real GDP using Hypothetical Eample

• Let us assume Country A, which only produces Apple. Now, the GDP of the country would be the quantity of apple multiplied by the price of apple. Let us assume country A produces 100 apples in year 1. The selling price of 1 apple being rupees 10.
• As the country produces only apples and no other product, the GDP of the country would be: GDP (year 1) = Quantity of apple * price of apple = 100 * 10 = 1000 rupees
• In year 2, suppose country A produces 110 apples. The selling price of apple now is 12 rupees. GDP (year2) = 110 * 12 = 1320 rupees
• Now, what does 1320 indicates. Is this the nominal or the real GDP of the country? This is the nominal GDP of country A. Now, the increase in GDP from 1000 to 1320 is not just because of the increase in quantity from 100 to 110 but also because of the increase in price from 10 to 12 rupees.
• So, if we want to know real growth of country’s economy, then we must calculate the GDP of country A of year 2 in prices of year 1. So, now price = 10 and quantity = 110 Therefore, GDP = 110*10 = 1100 rupees
• Now the difference between real and nominal GDP can clearly be seen, 1320 is the nominal GDP of country A and price adjusted 1100 is the real GDP of the country A. So, we can say that the real growth in GDP is 10% i.e., from rupees 1000 to 1100.

Nominal GDp

• Nominal GDP is an economic metric that measures the total market value of all finished goods and services produced by a country at their current market prices in a single year.
• It is defined as a GDP measure, expressed in absolute terms. The raw GDP data, before inflation is called Nominal GDP.
• Nominal GDP is the aggregate monetary value of the economic output produced during a particular financial year, within the nation’s border. It represents the GDP at prevailing prices in the market, i.e. the current market price.
• It includes all the changes in the prices of finished goods and services that took place in one year due to inflation or deflation.

Real GDP

• Real GDP, also known as inflation-adjusted GDP, measures the value of finished goods and services at constant base-year prices. The real GDP is inflation-adjusted or deflation with the use of nominal GDP and the GDP deflator.
• GDP deflator is a factor by which Nominal GDP is adjusted to calculate Real GDP. It adjusts gross domestic product by removing the effect of rising prices. It shows how much an economy’s GDP is really growing.
• Formula is: GDP Deflator = (Nominal GDP / Real GDP) * 100
• This includes changes in the general price level in a given year to provide an accurate picture of an economy’s growth using base-year prices. If the general price level changes from one year to the next, it is difficult to compare the amount of output across different years.
• By valuing the entire output of an economy using the average price of a base year, economists can use this measurement to analyze an economy’s purchasing power and growth potential in the long-term.
• Real GDP is considered as a true indicator of country’s economic growth. It exclusively considers the production and free from price changes or currency fluctuations.
• The real GDP reflects the nominal GDP of an economy if there were no prices changes due to inflation.

Nominal GDP vs Real GDP

Common Misconceptions

• An increase in GDP does not necessarily mean a nation has produced more output; it must be specified whether the GDP in question is nominal or real.
• An increase in nominal GDP may just mean prices have increased, while an increase in real GDP definitely means output increased.

Summary

• Nominal GDP and Real GDP both quantify the total value of all goods produced in a country in a year. However, Real GDP is adjusted for inflation, while Nominal GDP is not. Thus, real GDP is almost always slightly lower than its equivalent nominal figure.
• In most circumstances, the Real GDP shows a more accurate picture of a country’s economic performance. Because we can more easily compare it to past year figures. Thus, we can deduce whether a country really is better or worse off year over year.

5 Most Important Economic Indicators

An economic indicator is a statistic about an economic activity. Economic indicators allow analysis of economic performance and predictions of future performance.

Retail Sales – Retail sales are particularly important measure and function hand in hand with inventory levels and manufacturing activity. Most importantly, strong retail sales directly increase GDP, which also strengthens the home currency. When sales improve, companies can hire more employees to sell and manufacture more products, which in turn puts more money back in the pockets of consumers.

In general, an increase in retail sales indicates an improving. economy   

Inflation – If the RBI thinks inflation is rising, it’ll put on the economic brakes by raising interest rates.

Inflation can be both beneficial to economic recovery and, in some cases, negative. If inflation becomes too high the economy can suffer; conversely, if inflation is controlled the economy may prosper. With controlled, lower inflation, employment increases, consumers have more money to buy goods and services, and the economy benefits and grows. A low and stable inflation rate is a perquisite for sustained high economic growth.

Repo rates – Repo rates are one of the most important drivers of the economy. From affecting the inflation (decrease in repo rate leads to increase in inflation) directly to influencing the foreign exchange rate (increase in repo rate leads to fall in exchange rate due to strengthening of domestic currency), repo rate plays a central role in the money supply of an economy. Also, if repo rate decreases then the GDP of a country increases (increase in money supply leads to increase in demand of goods). Repo rate has a multiplying effect on the economy.

It is used by a central bank as a tool to manage the economy – either by raising the interest rate to curb inflation or lowering the interest rate to promote growth.

If the central bank increases the repo rate, then borrowers have to pay more for the money they borrowed. This reduces the amount of money they have for spending on other things and thus impacts the economy.

Foreign Direct Investment – Foreign Direct Investment (FDI) is a leading economic indicator which greatly influences the general economy as whole.

FDI which is a direct investment into the country from an entity in another country, either by setting up a new company or by way of a merger or acquisition etc., also indicates the positive perspective or approach of the overseas investors.

FDI has had a positive impact on an economy. FDI inflow supplements domestic capital, as well as technology and skills of existing companies. It also helps to establish new companies. All of these contribute to economic growth of an economy.

Total New Vehicle Sales – New car sales are a reliable economic indicator which tells us whether the economy is starting to pick up. People buy a car only when they feel certain about their job prospects and hence, feel financially secure. Further, once car sales pick up, sale of steel, tires, auto-components, glass etc., also starts to pick up as well. New car sales are a good indicator of economic growth.

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