Saturday, August 23, 2008

Real Gross Domestic Product (Real GDP)

Real Gross Domestic Product

Although GDP is the most common measure of a country’s output, it may not be the best measure. Real GDP measures the value of the total final output of a country's economy without the influence of inflation. Inflation is a general increase in the prices in an economy. Real GDP measures the output of a country’s final goods and services in constant dollars (i.e., using prices in a single base year to measure output in different years). (For example, it might measure output in 2003, 2004, and 2005 using prices from 2000.) When calculating real GDP, the base year is the year from which prices are used to calculate the value of output.

Nominal GDP in year x = prices in year x outputs in year x
Real GDP in year x = prices in the base year outputs in year x

A Simple Example of an Economy with One Product

To illustrate the difference between nominal GDP and real GDP, consider a simple economy that only produces one product, widgets. Suppose this economy produces 100 widgets in 2003 and the price of widgets in 2003 is $1. Thus, the economy’s nominal GDP in 2003 is $100. Suppose the economy produces 100 widgets in 2004, but the price of widgets in 2004 is $2. Nominal GDP in 2004 is $200. If one uses nominal GDP to measure output, one might think this economy produced more output in 2004 than 2003 (since nominal GDP in 2004 is larger than nominal GDP in 2003). Yet output in this economy was the same in 2003 and 2004. The reason nominal GDP is larger in 2004 than in 2003 is because the price of widgets increased. Real GDP attempts to measure the real change in output without the influence of inflation. In this simple example, let 2003 be the base year. Thus real GDP in 2003 is calculated by multiplying the quantity of output in 2003 by the price of widgets in 2003 (since 2003 is the base year).

Real GDP in 2003 = $1 100 = $100

Real GDP in 2004 is calculated by multiplying the quantity of output in 2004 by the price of widgets in 2003 (since 2003 is the base year).

Real GDP in 2004 = $1 100 = $100

Since real GDP in 2003 and 2004 is the same, it indicates real output did not change. Thus changes in real GDP are a better measure of changes in real output than changes in nominal GDP.
Per capita real GDP measures the real value of a country’s output per person. It is calculated by dividing real GDP by the country’s population.
Many economists think the single best measure of a country's standard of living is per capita real GDP because it measures the income of an average person in a country without the influence of inflation.

Economic Growth - Topics

No comments:

Post a Comment