Updated July 29, 2023
Definition of Real GDP
Real Gross domestic product is the GDP in which inflation is adjusted, or it is also referred to as GDP at Constant Price or base price. To find the GDP, it is important to fix the base year (most of the time, analyst prefers the previous year as the base year) first to analyze the real Gross domestic product from that base year to the current year.
The Real Gross domestic product is also referred to as the calculation of Gross domestic product at a constant price. It simply means that it measures the economy’s Gross domestic product at a Constant price. Where the economy is inflationary or deflationary. Therefore, to calculate the Real Gross domestic product, one needs to convert the value of goods and services at current prices to constant prices.
Elaboration of Real GDP
GDP stands for Gross Domestic Product. It is the total value of all individual goods and services produced within the domestic territory of a country during a financial year.
- P: Stands for the Market price.
- Q: Stands for the number of goods produced during the year.
- S: Stands for services.
To calculate the Gross domestic product, Multiply the Value of Goods and services by the quantity produced.
- Constant Price/Base Price: It means the constant and fixed price or the previous year’s price. It is a base year’s price.
- Base Year: It is a standard previous year in which no major economic changes occurred.
We can use the following formula for the conversion of GDP at the current price into GDP at a constant price:
Example
Let us understand the calculation of GDP at current and constant prices with the below example:
There are three categories of goods named X, Y, and Z. We need to calculate the value of a domestic product at a current and constant price for 2005.
Goods |
2002 |
2005 |
Domestic Product in 2005 |
|||
Qty | Price/unit | Qty | Price/unit | At current price | At constant Price | |
X | 100 | 20 | 100 | 30 | 3000 | 2000 |
Y | 500 | 15 | 500 | 10 | 5000 | 7500 |
Z | 200 | 10 | 200 | 20 | 4000 | 2000 |
12000 | 11500 |
From the above table, it has been observed that the value of a domestic product at its current price amounts to Rs 12,000, whereas at the constant price of 2002, it amounts to Rs 11,500 only. There is no increase in output by the value of the domestic product has increased by 4.35% over the value at a constant price. This increase is not a real increase.
Nominal GDP
Nominal GDP is referred to as GDP at the Current Market price.
Current Price: It means the prices of goods and services currently prevailing in the market.
An increase in Gross domestic product’s value compared to the Previous year’s value represents economic development. But it should be noted whether the increase in the value of a Gross domestic product is due to an increase in the number of goods and services produced or an increase in the prices. If the increase is due to the increased production, it represents a real increase.
Let’s understand the calculation of GDP with the help of an example.
Example #1
Suppose country X produced 1200kg of oranges in 2017. And the price per KG is Rs 12. Therefore, the nominal Gross domestic product in 2017 is Rs 14,400.
If Country X produced 1500kg of oranges in 2018, the price would increase to Rs16. Therefore, in 2018 the nominal Gross domestic product was Rs 24,000.
Example #2
Suppose country A produced 1000 pieces of a refrigerator in 2015. And the price per piece is Rs5000. Therefore, the nominal Gross domestic product in 2015 was Rs 50,00,000.
If Country X produced 1500 pieces a refrigerator in 2016, the price would increase to Rs5,500. Therefore, in 2018 the nominal Gross domestic product was Rs 82,50,000.
Gross Domestic Product Deflator
It converts the Nominal Gross domestic product into Real Gross domestic product as the real GDP is based on the base year.
Let’s understand with the help of the below example.
Goods |
Quantity | Current Period |
Base Period |
||
Price | Expenditure | Price | Expenditure | ||
Oranges | 400KG | 20/KG | 8000 | 12 | 4800 |
Apple | 100KG | 12/KG | 1200 | 10 | 12000 |
Grapes | 400KG | 25/KG | 10000 | 16 | 6400 |
Nominal GDP | 19200 | Real GDP | 23200 |
The deflator for the current period
- GDP Deflator = Nominal GDP/Real GDP*100
- GDP Deflator = (19200/23000)*100
- GDP Deflator = 82.76
Orange consumption deflator
- Orange deflator = (8000/4800)*100
- Orange deflator = 167
Apple consumption deflator
- Apple Deflator = (1200/12000)*100
- Apple Deflator = 10
Grapes consumption deflator
- Grapes Deflator = (10000/6400)*100
- Grapes Deflator = 156
From the above, it has been concluded that the Consumption of Oranges in the current year is Rs 8000, Apple consumption is Rs 1,200, and Rs 6,400 for Grapes consumption.
Also,
Advantages of Real Gross Domestic Product
- It helps compare two financial years, as its calculation is based on the base year.
- It helps in providing the real picture of an economy.
- This method is the first preference of all economists as it considers the effect of inflation or deflation.
Drawbacks of Real Gross Domestic Product
- It isn’t easy to calculate because it involves the conversion of market price to constant price.
- It requires a lot of attention to the inflation rate.
- It involves a deep analysis of Market price and its conversion to constant price.
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