What is Real GDP?
Real Gross domestic product is the GDP in which inflation is adjusted or it also referred to as GDP at Constant Price or base price. To find the GDP it is important to fix base year (most of the time analyst prefers the previous year as base year) first so that one can analyze the real Gross domestic product from that base year to current year.
Elaboration of Real GDP
- GDP: It 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.
GDP = P(Q) + P(S)
- 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 with quantity produced.
- Constant Price/Base Price: It means the price which is constant and fixed or previous year price. It is basically a base year’s price.
- Base Year: It is a standard previous year in which no major economic changes have taken place.
Definition
The Real Gross domestic product is also referred to as calculation of Gross domestic product at a constant price. It simply means that it is a measure of economy Gross domestic product at Constant price. Where the economy is inflationary or deflationary. Therefore, in order to calculate Real Gross domestic product, one needs to convert the value of goods and services at current prices to constant prices.
We can use the following formula for conversion of GDP at current price into GDP at a constant price:
Example
Let understand the calculation of GDP at current and constant price with below example:
There are three categories of goods named X, Y, and Z. We need to calculate the value of a domestic product at current and constant price for the year 2005.
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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 current price amounts to Rs 12,000, whereas at the constant price of 2002, it amounts to Rs11,500 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 Current Market price.
Current Price: It means the prices of goods and services currently prevailing in the market.
Increase in the value of a Gross domestic product as compared to the value of Previous year represent 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 produces 1200kg oranges in 2017. And the price per KG is Rs12. Therefore, the nominal Gross domestic product in 2017 is Rs14,400.
Now, if the Country X produces 1500kg oranges in 2018. And the price increased to Rs16. Therefore, in 2018 the nominal Gross domestic product is Rs 24,000.
Example #2
Suppose country A produces 1000 pieces of a refrigerator in 2015. And the price per piece is Rs5000 Therefore, the nominal Gross domestic product in 2015 is Rs50,00,000.
Now, if the Country X produces 1500 pieces of a refrigerator in 2016. And the price increased to Rs5,500. Therefore, in 2018 the nominal Gross domestic product is Rs 82,50,000.
Gross Domestic Product Deflator
It is used to convert 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 |
Deflator for 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
Now 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,
Real GDP = Nominal GDP/GDP Deflator.
Advantages of Real Gross Domestic Product
- It helps in the comparison of two financial years, as its calculation based on base year.
- It helps in providing the real picture of an economy.
- This method is the first preference of all economist as it takes the effect of inflation or deflation into consideration.
Drawbacks of Real Gross Domestic Product
- It is very difficult to calculate because it involves the conversion of market price to constant price.
- It requires a lot of attention towards the inflation rate.
- It involves deep analysis of Market price and its conversion to constant price.
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