GDP impacts customers and businesses alike. This acronym stands for gross domestic product and allows a country to measure its economy. Both real GDP and nominal GDP assess the total value of all finished goods and services produced over a specified period. However, they are not the same. Knowing the difference between the two can help you make wiser business decisions and better investments.
Nominal GDP Definition
What is the state of the economy? Is it better today than it was five or 10 years ago? Has purchasing power increased? GDP values can help answer these questions. This monetary measure offers accurate insights into a country's economic performance in a specific year. Its primary components include:
- Business investments.
- Personal consumption expenditures.
- Exports minus imports.
- Government spending.
Real GDP and nominal GDP are the main ways to measure a country's gross domestic product. According to the nominal GDP definition, this number reflects all recent changes in the market. It tracks the total economic output of a country without factoring in the effects of inflation or deflation.
In general, economists use nominal GDP to compare different quarters of output over a one-year period. For example, they may compare the economic performance of different countries, different regions or different cities within the same country in the last 12 months. Nominal GDP measures the total market value of all goods and services produced in that geographical region or country in a single year.
What Does Real GDP Measure?
Real GDP is a more accurate indicator of economic growth. The real GDP formula is calculated by taking a base year as a determinant. Unlike nominal GDP, this number reflects the total market value of products and services adjusted for price changes due to inflation or deflation.
For example, if you want to measure a country's economic growth over the past five years, determine the real GDP levels. If you are interested in the current year only, calculate the nominal GDP growth rate. Real GDP and nominal GDP levels are equal only when the market prices of the base year are the same as those of the current year.
Nominal Versus Real GDP
There are quite a few differences between real GDP and nominal GDP. The first one measures the value of economic output adjusted for inflation, while the latter doesn't take inflation into account.
Additionally, nominal GDP is used for making price comparisons within the same year. Real GDP, on the other hand, allows you to compare economic performance over several years using a specific year's average prices.
Be aware that GDP isn't a complete indicator of national well-being or living standards. For example, rebuilding a city after a major disaster may increase its GDP but it overlooks the financial losses incurred by the government and citizens. This number only reflects the total of everything a country produces over a year or more. It is, however, an acceptable measure of economic growth.