Real GDP: Definition & Formula

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  • 0:02 Real Gross Domestic Product
  • 0:36 Real vs. Nominal GDP
  • 2:49 Formula for Real GDP
  • 4:48 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

National economies are measured by the value of the goods and services they produce. In this lesson, you'll learn about real gross domestic product, how it's related to a nation's production, and how it's calculated.

Real Gross Domestic Product

Real gross domestic product (GDP) is the inflation-adjusted dollar value of all goods and services produced during a stated period. Only goods that are final products are counted, and they aren't necessarily counted when they are sold; they are counted when they are done being produced.

Take cars, for example. First of all, the engine, tires, seats, and other parts of a car are not final products - only the vehicle is a final product. Second, the car isn't counted in GDP when a consumer purchases it; it is counted as GDP when it transfers from the assembly line to the dealership.

Real vs. Nominal GDP

In real GDP, the effect of inflation is factored into the GDP calculation, allowing you to compare GDP over time. Nominal GDP is the term for when inflation isn't accounted for. An oversimplified example demonstrates why this distinction is important.

Imagine our own hypothetical country that produces one single product - pencils. Ten years ago, we produced 100 pencils at a cost of ten cents each, and thanks to demand and increasing productivity, our country's economy has grown 5% per year. But because of that growing economy, inflation has also been an issue, growing an average of 7% per year. This table shows the changes in output each year, beginning with year one (or ten years ago):

Sample GDP Chart

The quantity of pencils we produce goes up each year because our economy is growing by 5% per year. That is what we usually want to know when we look at GDP - if and by how much the economy is growing. But in healthy economies, prices rise over time. The rate of this rise in prices is known as inflation. You can see the impact of the 7% inflation rate in the second column in the table. The price of our pencils nearly doubled, from ten cents to almost 20 cents.

Since GDP is the value of all goods produced, we calculate it by multiplying the total number of goods by their final product price (which is not necessarily the price the end user pays). When we do that for each year based on new prices, we get nominal GDP, or how much was produced, stated in current dollars for that year.

But, if we want to compare the real increase in GDP, meaning the real increase in the amount of goods produced, we need to consider the impact of inflation. The column in the table labeled Real GDP shows that result. To compare the impact inflation has, especially when it is as high as 7%, look at the size of the economies after ten years. On a real basis, the economy has grown by about 55%, from $10.00 to $15.51. On a nominal basis, the economy has grown 285%, from $10.00 to $28.52. While both statements are technically true, nominal GDP clearly overestimates the amount of real production growth that has occurred.

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