The aim of the comparison presented in this article is to clear out the difference between nominal and real GDP.
Although, the size of an economic system may vary from a small business to an entire economy of a country, the basic factors taken into consideration for performance evaluation remain the same. Just like the performance of any business is evaluated by the total value of sales made by it in a financial year or a business quarter, the performance of a country’s economy is evaluated using the concept of Gross Domestic Product (GDP). It comes in two varieties, which vary in their method of calculation. They are known as real and nominal GDP.
The Basic Concept
The Gross Domestic Product is the total value of the products, as well as services created in an economy, during one financial year, according to current or past market prices.
Consider the economy to be one singular business unit, combining all kinds of services and production units together. The valuation of the total sales and services offered by this business unit is the GDP. GDP per capita is the GDP value, divided by the total population number of the country.
GDP could be calculated by either evaluating the expenditures made by the economy or the income earned by the constituents of the economy. Whatever be the method, the most important factor of consideration is the market prices used for valuing goods and services. That is the point where real and nominal GDP differ.
Nominal GDP is calculated by valuing the goods and services produced by the country in a financial year, according to the prevalent market prices. These market prices may have inflated in the current year, compared to the last year. This fact has a large impact on the calculation.
Real GDP is calculated by evaluating the prices of the goods and services, according to market prices of any previous year, which is mostly termed as the base year for calculation. For example, if real GDP for year 2010 is to be calculated, the base year might be 2008. In that case, it will be calculated according to market prices of 2008.
Difference in Calculation
The only difference arises in the variable which is market price. While real GDP will take the prices of past years into consideration, nominal GDP will take only current prices into consideration. Thus, the real one can be adjusted for inflation or deflation in market prices, which may have occurred during the period between the current financial year and past base year, which is used for calculation.
Real GDP per capita represents the change in GDP, with respect to market price in some past year, while nominal value reflects the economy’s productivity in the current year, according to latest market prices. As discussed before, while the former is adjusted for inflation, the latter isn’t. That’s the gist of the difference between them.