Real gross domestic product
Real Gross Domestic Product (real GDP) is a macroeconomic measure of the value of economic output adjusted for price changes (i.e., inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantity of total output. GDP is the sum of consumer Spending, Investment made by industry, Excess of Exports over Imports and Government Spending. Due to inflation GDP increases and does not actually reflect the true growth in economy. That is why inflation rate must be subtracted from the GDP to get the real growth percentage called the real GDP.
Relationship with nominal GDP
Real GDP is an example of the distinction between real vs. nominal values in economics. Nominal gross domestic product is defined as the market value of all final goods produced in a geographical region, usually a country. That market value depends on the quantities of goods and services produced, and their respective prices (referred in lower case below). Real gross domestic product accounts for price changes that may occur due to inflation. If prices change from one period to the next but actual output does not, nominal GDP would also change even though output remained constant. To adjust for price changes, real GDP is calculated using prices from a specific year, the base year. This allows real GDP to accurately measure changes in output separate from changes in prices.
If a set of real GDPs from various years are calculated, each using the quantities from its own year, but all using the prices from the same base year, the differences in those real GDPs will reflect only differences in volume.
An index called the GDP deflator can be obtained by dividing, for each year, the nominal GDP by the real GDP, so that the GDP deflator for the base year will be 1. It gives an indication of the overall level of price change (inflation or deflation) in the economy.
- GDP deflator for year t = nominal GDPt / Real GDPt
Real GDP growth on an annual basis is the nominal GDP growth rate adjusted for inflation. It is usually expressed as a percentage.
Nomenclature: "GDP" may refer to "nominal" or "current" or "historical" GDP, to distinguish it from the real GDP. The real GDP is sometimes called "constant" GDP because it is expressed in terms of constant prices. Depending on context, "GDP" may also refer to real GDP.
Relationship with purchasing power
Since real GDP is adjusted for inflation throughout the year, it can be thought of in terms of purchasing power.[clarification needed] As a result, individual purchasing power can be measured by real GDP per capita, i.e., real GDP divided by the size of the population.