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Real GDP Per Capita

Scholasticus K Jan 28, 2019
Real Gross Domestic Product (GDP) per capita is an important parameter in macroeconomics. Here, we will understand the concept of GDP and the need of calculating the real GDP. We will also take a look at some limitations of real GDP per capita.
Gross Domestic Product (GDP), also called nominal GDP, is an important indicator of the performance of an economy. It is the value of total amount of goods and services produced by an economy, within its borders, over a period of time. GDP of a country changes with the  production increase - more goods and services means greater final market value.
However, GDP can also increase if the amount of goods produced remains the same, but the final market price of the goods has changed on the account of inflation. To offset the effect of inflation on the GDP, economists use the concept of real GDP.
Real GDP, also called constant-price GDP, or inflation-corrected GDP, is final market value of goods, services produced by an economy over a period of time, with the effect of inflation taken into account by comparing the current value of goods with the price of the same number of goods in a pre-established base year.
Let's see an example of the concept of real GDP.

Suppose a country produces 1 0 cars in year 1, with each car at $1000. The final market value of the cars in year 1 will be $10,000. In year 2, 10 cars are produced again, with the same specification and features as year 1. Suppose each car is priced at $1200. The market value in year 2 will be $12,000.
If we consider year 1 as the base year,
  1. Year 1: Nominal GDP = 10,000 & Real GDP = $10,000
  2. Year 2: Nominal GDP = 12,000 & Real GDP = 10,000
In year 2, the country produced the same number of cars as in year 1. However, due to an increase in the price of cars (inflation), the country saw a higher nominal GDP, whereas the real GDP remained the same.
To measure real GDP, a base year is chosen, and the total output of goods and services in the current year is priced at the rates of that base year. Economists also use an index to measure inflation, or deflation, in an economy. This index is known as GDP Deflator.

GDP Deflator = Nominal GDP/Real GDP x 100

Using the same equation, we can calculate the value of real GDP for any given year.

Real GDP = Nominal GDP/GDP Deflator x 100

The value of GDP Deflator is reported by the Bureau of Economic Analysis (BEA). Currently, 2005 is used as the base year, with the GDP Deflator set to 100.

Calculating Real GDP Per Capita

Now that we have understood the terms nominal and real GDP, we can take a look at the concept of real GDP per capita. In simpler terms, real GDP per capita is the ratio of real GDP of a country to its average population.

Real GDP Per Capita = Real GDP/Average Population
So, if a country has a real GDP of $1,000,000, and its population is 10,000, its real GDP per capita will be $100. Mentioned here is information about the real GDP per capita for some developed countries of the world.

Countries and their Real GDP Per Capita

  • Norway - 75,504
  • United States - 59,531
  • Netherlands - 48,223
  • Australia - 53,799
  • Austria - 47,290
  • Sweden - 53,442
  • Denmark - 56,307
  • UK - 39,720
  • Germany - 44,469
  • Belgium - 43,323
  • France - 38,476
  • Japan - 38,428
  • Italy - 31,952

Limitations of Real GDP Per Capita

As per the definition of real GDP, it only measures the value of goods and services that can be sold in market. It doesn't consider the goods that can be produced, but cannot be exchanged in the market. For example, the time one spends on cleaning his house, washing his car, preparing meals for himself, etc., is ignored in the calculation of real GDP.
Reports over the years have shown that advances in industrial sector have done great damage to our environment. Forests have been cleared to make way for companies and factories. The output produced by these companies is included in the real GDP of the country, but the long-term damage it does to the environment cannot be measured.
Economists believe that as real GDP fails to take this factor into account, it cannot be used to measure the progress of a country.
As mentioned earlier, real GDP per capita is used as an indicator of, the standard of living of people in a country. However, it doesn't take into account the time spent by people on leisurely activities. Generally, people wish to spend less time at their workplace, so that they can spend more time with their loved ones.
Lesser work hours may cause lesser output, which can reduce the real GDP of a country. However, in this case, lesser GDP may not mean that people are worse off, instead it indicates that people are satisfied and happier.
As we can see that real GDP comes with its own set of limitations. Despite this, it is considered an important metric by governments and economists around the world. One of the prime reasons for this is the fact that it closely reflects the need of the society to produce more goods and services, and as a result, earn more income.
While it cannot accurately measure the happiness, or satisfaction level of people in a country, it is an important parameter of economic growth of a country and its citizens.