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In calculating GDP we find two possibilities:
- When a year is determined as the base year, it is called Real GDP or GDP with constant prices.
- On the other hand, if the prices of that year are used, the GDP obtained is called Nominal GDP or GDP with current prices.
What is the difference between nominal and real GDP?
Although normally we usually hear the concept of Gross Domestic Product without further ado, it is necessary to know what is nominal GDP and real GDP because depending on which is calculated we will obtain different results and, in addition, we will have to make a different interpretation.
When GDP falls, it may be due to lower prices or a decrease in the country’s production. Therefore, these concepts are essential to know what are the causes of increases or decreases in GDP. Let’s see what each of them is.
On the one hand, the Real GDP refers to value of all the production of a country at constant prices, that is to say, that the variations in prices that they produce over time, due to inflation, supply, demand, etc., are not taken into account. This allows comparisons between the products and services produced by a country, isolated from the price differences that may occur in different periods, which allows us to see how much the economy is growing Really.
On the other hand, the Nominal GDP yes that takes into account those price changes that have occurred over a period for calculating the value of production of that territory. This is why it uses market prices and values inflation or deflation to calculate the value of everything that has occurred during that year or quarter.
What are the formulas to calculate real GDP and nominal GDP?
The nominal GDP calculation, the one that refers to the value of the goods and services produced taking into account the price changes can be done in three different ways according to the different data of utilities. For this, we recommend that you consult the complementary post that we have for it: how to calculate the GDP through the 3 routes, where you can easily see each and every one of the possibilities.
On the other hand, here we are going to explain how to obtain real GDP. You should know that you will need two specific data: the nominal GDP and the GDP deflator. In this way, the formula to calculate GDP real would look like this:
Real GDP: nominal GDP / GDP deflator
The GDP deflator is an index that allows us to know the variation of prices in a country during a certain time. It is like the CPI but only refers to the prices of consumer products and services. Thus, the relationship between nominal GDP and the deflator will give us the value of the Gross Domestic Product real for the value the growth or decrease of production.
In conclusion, we already know what is real and nominal GDP and how are they calculated. Now we can carry out our calculations to obtain these indices and evaluate them to understand the development of the national economy of each country.