Real gross domestic product is a measure which accounts for the inflation-adjusted value of all goods and services an economy produced in a given year. For economists and governments determining the value and assessing the strength of an economy, this value is one of the most important metrics to reference.
Real GDP considers both nominal GDP and GDP deflators in establishing the value of goods and services generated within an economy. This metric is used beyond measuring for economic growth, as it can also be applied to the analysis of a currency’s purchasing power within an economy.
This article will explain what is real GDP and how to find real GDP. This article will also illustrate how to calculate real GDP, how to format a real GDP calculator, and address the question, “Why is real GDP a more accurate measure of an economy’s production than nominal GDP?”
Real GDP Definition
Real gross domestic product is a macroeconomic metric which measures the inflation-adjusted value of the goods and services produced by an economy over a period. The value is considered the total economic output of a country and is often used by economists and governments to estimate the growth and overall strength of a country’s economy.
In the United States, a quarterly report on GDP including both real and nominal GDP data is published by the Bureau of Economic Analysis (BEA).
What Is Real GDP
Real GDP Formula
Real gross domestic product is calculated by dividing the nominal GDP for a given period by the GDP deflator. Nominal gross domestic product (Nominal GDP) is measured in the value of ‘current dollars,’ whereas the GDP deflator is a measurement of inflation since a given base year, set by the BEA, which adjusts the nominal GDP for inflation to yield the answer.
RGDP = Nominal GDP / GDP Deflator
Where:
RGDP = Real gross domestic product
How To Calculate Real GDP
Calculate Step by Step
- Determine the period GDP will be measured during.
- Identify the nominal GDP for the period being measured and the corresponding GDP deflator.
- Divide the nominal GDP by the GDP deflator to yield adjusted GDP for the period.
Example
An economist is measuring the GDP in the United States for the fourth quarter of 2020. Based on information published by the BEA, the economist has identified the following values:
GDP Deflator (2020): 114.44
Nominal GDP (2020): $21.48 trillion
With this information, the economist can use the real GDP formula to calculate total economic output within the United States in the fourth quarter of 2020. The economist will populate the formula as follows:
RGDP = Nominal GDP / GDP Deflator
RGDP = 21,480,000,000,000 / 114.44
The economist will now divide the nominal GDP by the GDP deflator to solve:
RGDP = 21,480,000,000,000 / 114.44
RGDP = 187,696,609,557
RGDP = $18.77 trillion
After solving for GDP and rounding, we can determine that economic output within the United States for the fourth quarter of 2020 was $18.77 trillion. This value represents the total economic output of the United States during this period, adjusted for inflation.
Context Example
Having information on real GDP is important for governments analyzing the strength of their economy. For example, during the onset of the COVID-19 pandemic, the United States economy was largely shuttered due to protection protocols.
As a result, GDP in the United States dropped drastically during the first and second quarters of 2020. By the third quarter of 2020, the economy began to reopen as protection protocols were lifted, leading to a surge in GDP as the economy resumed producing goods and services.
During this time, the United States was closely monitoring the output of its economy to assess economic health throughout the initial stages COVID-19 pandemic. As shown in the table below, sourced from the BEA, percent changes over this period provides a clear view into how the pandemic impacted the United States economy:
Tips for Calculating
Tip Number 1:
The base year used to select the GDP deflator will significantly influence the adjusted GDP. The BEA identifies several base years for determining the GDP deflator. Since the GDP deflator adjusts the nominal GDP for inflation, the base year selected will change the value of the GDP deflator – thus impacting the real GDP value. When calculating for this adjusted GDP, make sure to choose the proper base year, typically identified by the BEA, to produce an accurate result.
Tip Number 2:
Real GDP measures a country’s economic output over the course of a year by adjusting nominal GDP for inflation. Nominal GDP within the United States is calculated by considering the consumption, government spending, and other actions within an economy in a given year. The formula for GDP = Consumption (C) + Government Spending (G) + Investment (I) + Net Exports (NX). The result of this formula is then divided by a GDP deflator to yield real GDP.
Tip Number 3:
Real GDP will always be lower than nominal GDP during inflationary periods. Since prices of goods and services rise during inflationary periods, nominal GDP can be a misleading figure, which explains why real GDP is always a smaller value when adjusted for inflation. Alternatively, this type of GDP will always be higher than nominal GDP during deflationary periods. Since the prices of goods and services decrease during as a result of deflation, nominal GDP may appear lower and underestimate the actual health of an economy.
Real GDP Calculator Using Microsoft Excel
This type of GDP can be calculated by using Microsoft Excel. To build a real GDP calculator, follow the steps shown below.
Insert the following formula into the cell C5 for adjusted GDP as demonstrated:
=(C2/C3)
This formula will yield the GDP as a several-trillion-dollar figure. To round the GDP value down to be measured in the trillions, insert the following formula into the cell below:
=C5*0.0000000001
How is Real GDP a More Accurate Measure of an Economy’s Production than Nominal GDP?
A common question asked regarding GDP is, “How is Real GDP a More Accurate Measure of an Economy’s Production than Nominal GDP?”
Real GDP is more accurate and favored by economists than nominal GDP, as nominal GDP does not consider inflation. Inflation decreases the purchasing power of currency. As a result of inflation, the price of goods and services rise during a period.
Although these prices rise, the nominal GDP formula (GDP = C + G + I + NX) does not take price fluctuations into account, as the product of the formula is simply the sum of the economic output of a country measured in “current collars.”
To adjust nominal GDP for inflation, a GDP deflator based on a predetermined base year is used. Dividing nominal GDP by this GDP deflator produces a GDP value adjusted for the amount of inflation which occurred over a given period.
In periods of high inflation (or deflation), the adjusted GDP more accurately describes the overall health and strength of an economy. Major differences between the values of real and nominal GDP will show if significant inflation is occurring. Governments can then enact the proper economic policy of most benefit to an economy, rather than potentially damaging the economy based on misleading information.
Takeaways
For those asking “What is Real GDP?”, this kind of adjusted GDP is a popular measurement of the economic output of a country and is used to gauge an economy’s overall health. This value is calculated by dividing nominal GDP for a given period by a GDP deflator associated with a base year.
Knowing how to find adjusted GDP is essential, as this is a more accurate measurement of a country’s economic health as it accounts for inflation or deflation.
