the difference between nominal gdp and real gdp is
Real GDP (Gross Domestic Product) refers to the total monetary value of the final products and services produced by the country’s residents in a year at market prices in a specified base year. Correspondingly, nominal GDP refers to the value of all products and services produced in a year calculated at the current market price.
In simple terms, the nominal GDP refers to the number of goods and services produced in a certain period multiplied by the “currency price” or “market price.” Hence, the nominal GDP growth rate is equal to the sum of the growth rate of actual GDP and the inflation rate.
Therefore, even if the total output does not increase and only the price level rises, the nominal GDP will still rise. In the case of increasing prices, the rise in GDP is just an illusion. What matters is the actual rate of change in GDP. Therefore, when using the indicator of GDP, you must also use the GDP deflator adjusting Nominal GDP to reflect real changes in output accurately.
The relationship between them
Nominal GDP growth rate = Real GDP growth rate + Inflation rate
Real GDP growth rate = nominal GDP growth rate-inflation rate
GDP deflator = (nominal GDP / real GDP) * 100
To illustrate how to calculate real GDP, imagine that we want to compare the 2016 and 2017 output in producing apple and banana. We can choose a group of prices at the beginning, called base-year prices, such as,
A=apple price in 2016,
B=banana price in 2016
C=apple price in 2017,
D=banana price in 2017
E=apple price in 2018,
F=banana price in 2018.
These base year prices are then used, to sum up, products and services to value different products for the two years.
Nominal GDP is like the following,
2016 Nominal GDP = (A×the number of apples in 2016)+ (B×the number of bananas in 2016)
2017 Nominal GDP = (C×the number of apples in 2017)+(D x the number of bananas in 2017)
2018 Nominal GDP = (E×the number of apples in 2018)+(F x the number of bananas in 2018)
Real GDP is as below,
2016 Real GDP = (A×the number of apples in 2016)+ (B×the number of bananas in 2016)
2017 Real GDP = (A×the number of apples in 2017)+(B x the number of bananas in 2017)
2018 Real GDP = (A×the number of apples in 2018)+(B x the number of bananas in 2018)
It should be noted that 2016 prices are used to calculate real GDP for all three years. Due to constant prices, real GDP changes in different years only when output changes. Since the ability of a society to provide economic satisfaction to its members ultimately depends on the number of products and services, real GDP offers a better measure of economic welfare than nominal GDP.
When we discuss real GDP, it seems that the base year value used to calculate the price of this indicator has never changed. If this is true, then this price has become more and more inaccurate over time. For example, in recent years the cost of computers has fallen sharply. In contrast, the amount of studying at university has increased in the previous years. When valuing computer production and education, using rates of 10 or 20 years ago will be misleading.
If so, the prices will be regularly updated to calculate real GDP. A new base year is selected approximately every five years. Prices are then fixed and used to measure year-to-year changes in the production of goods and services until the base year is updated again.