Real Gross Domestic Product (Real GDP): How to Calculate It, vs. Nominal

What Is Real Gross Domestic Product (GDP)?

Real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year. Real GDP is expressed in base-year prices. It is often referred to as constant-price GDP, inflation-corrected GDP, or constant-dollar GDP. Put simply, real GDP measures the total economic output of a country and is adjusted for changes in price.

Understanding Real Gross Domestic Product (GDP)

Real GDP is a macroeconomic statistic that measures the value of the goods and services produced by an economy in a specific period, adjusted for price changes. Essentially, it measures a country's total economic output, taking price changes into account—whether they are due to inflation or deflation.

Governments use both nominal and real GDP as metrics for analyzing economic growth and purchasing power over time. This is done using the GDP price deflator (also called the implicit price deflator), which measures the changes in prices for all of the goods and services produced in an economy. To determine real GDP, economists take nominal GDP and adjust it for price changes.

The Bureau of Economic Analysis (BEA) provides a quarterly report on GDP with headline data statistics representing real GDP levels and real GDP growth. Nominal GDP is also included in the BEA’s quarterly report under the name current dollar. Unlike nominal GDP, real GDP accounts for changes in price levels and provides a more accurate figure of economic growth.

Real GDP Calculation

Calculating real GDP is a complex process typically best provided by the BEA. In general, you calculate real GDP by dividing nominal GDP by the GDP deflator (R).

$\begin{aligned}&\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{R}}\\&\textbf{where:}\\&\text{GDP}=\text{Gross domestic product}\\&\text{R} =\text{GDP deflator}\end{aligned}$​Real GDP=RNominal GDP​where:GDP=Gross domestic productR=GDP deflator​

The BEA provides the deflator on a quarterly basis. The GDP deflator is a measurement of inflation since a base year. Dividing the nominal GDP by the deflator removes the effects of inflation.

For example, if an economy's prices have increased by 1% since the base year, the deflating number is 1.01. If nominal GDP was $1 million, then real GDP is calculated as $1,000,000 / 1.01, or $990,099.

What Is Nominal GDP?

As noted above, governments rely on both real and nominal GDP to get an idea of where the economy is heading. While real GDP takes inflation (or deflation) into account, nominal GDP is a macroeconomic assessment of the value of goods and services using current prices in its measure. As such, nominal GDP is also referred to as the current dollar GDP.

Because nominal GDP measures how well the economy is doing without factoring in price changes due to inflation or deflation, it may actually inflate growth because all of the goods and services that are used to determine nominal GDP are valued at prices in the current year.

The easiest way to calculate nominal GDP is by multiplying real GDP by the GDP deflator:

$\begin{aligned}&\text{Nominal GDP} = \text{Real GDP} \times \text{GDP Deflator} \\\end{aligned}$​Nominal GDP=Real GDP×GDP Deflator​

You can also calculate it using the expenditure method:

$\begin{aligned}&\text{Nominal GDP} = \text{C} + \text{I} + \text{G} + ( \text{X} - \text{M} ) \\&\textbf{where:} \\&\text{C} = \text{Consumer spending} \\&\text{I} = \text{Business investment} \\&\text{G} = \text{Government spending} \\&\text{X} - \text{M} = \text{Total net exports} \\\end{aligned}$​Nominal GDP=C+I+G+(X−M)where:C=Consumer spendingI=Business investmentG=Government spendingX−M=Total net exports​

Real GDP vs. Nominal GDP

Because GDP is one of the most important metrics for evaluating the economic activity, stability, and growth of goods and services in an economy, it is usually reviewed from two angles: real and nominal. The table below highlights some of the main differences between the two types of GDP used by economists, businesses, investors, and government leaders.

Economists use the BEA’s real GDP headline data for macroeconomic analysis and central bank planning. As the table above indicates, the main difference between nominal GDP and real GDP is the taking of inflation into account.

Since nominal GDP is calculated using current prices, it does not require any adjustments for inflation. This makes comparisons from quarter to quarter and year to year much simpler to calculate and analyze. Keep in mind, though, that any comparisons are less relevant.

As such, real GDP provides a better basis for judging long-term national economic performance than nominal GDP. Using a GDP price deflator, real GDP reflects GDP on a per-quantity basis. Without real GDP, it would be difficult to identify just from examining nominal GDP whether production is actually expanding—or if it's just a factor of rising per-unit prices in the economy.

A positive difference in nominal minus real GDP signifies inflation and a negative difference signifies deflation. In other words, inflation occurs when nominal GDP is higher than real GDP. Deflation happens when real GDP is higher than nominal GDP.

Example of Real GDP vs. Nominal GDP

Real GDP will be lower than nominal GDP during inflationary periods and is higher when the economy experiences deflation. Let's demonstrate this using the example of a hypothetical country. Suppose it had a nominal GDP of $100 billion in 2000, which grew by 50% to $150 billion by 2020. Over the same period of time, inflation reduced the relative purchasing power of the dollar by 50%.

Looking at just the nominal GDP, the economy appears to be performing very well, whereas the real GDP expressed in 2000 dollars would actually indicate a reading of $75 billion, revealing in fact a net overall decline in economic growth had occurred. It is due to this greater accuracy that real GDP is favored by economists as a method of measuring economic performance.

The Bottom Line

Real GDP is an economic metric that is used to describe the economic output of a country within a specific year. It reflects the value of all goods and services produced while factoring inflation into its calculation. You may often hear it referred to by other names, such as constant-price GDP or inflation-corrected GDP. This is in contrast to nominal GDP. This metric uses current prices to measure the output for goods and services.