Gross Domestic Product Explained & GDP Growth Measures (Real GDP Vs. Nominal GDP)

What is the GDP? The gross-home product, or GDP, is the total value of the countries’ goods and services produced within a preset period of time. Usually, GDP is assessed on the calendar year basis. More precisely, GDP can be calculated with the addition of up the next components: consumption, investment, government spending, and net exports, or the passion between exports and imports. Consumption includes personal items such as food, utilities, rent, clothing, fuel, and financial services received by individuals.

It is important to notice that casing purchase costs are NOT included in this category. That is by the largest element of GDP significantly. Investments makes reference to capital expenditures, which would include costs associated with building new factories, machinery business expenses, new home purchases, business inventory changes. One important note to make on investments is that stock and bond purchases are not considered in this category as they don’t add to the GDP, or any real output.

The Government spending category includes state and local governments as well as the government. This category is the next largest component of the gross-home product. Items such as school-teacher wages and pensions, senator and congressman salaries, and military services goods are some of the major components. Finally, each year net exports is simply the difference between the amount of goods we export and transfer.

This would take into account all foreign consumption of our goods, or result from our economy. You might have heard the conditions “real” GDP growth or “nominal” GDP growth and wondered the actual difference was. The difference is based on the known reality that nominal GDP does not take into account price changes, or inflation, while real GDP will.

Nominal GDP steps the aggregate prices of goods based on current prices, while real GDP, also referred to as continuous-price GDP, represents gross home product in constant dollars. This means that real GDP shall measure the value of output in conditions of prices from a base year. For example, suppose that the economy produced 10 billion dollars worth of cars in 2006. Since this will be our basis year, real and nominal GDP will be the same, 10 billion dollars. However, in 2007, 12 billion dollars worth of cars were produced using 2007 prices.

Additionally, the number of cars produced in 2007 coming in at 2006 levels would result in an output of 11 billion dollars. Applying this example, you can see the next: 2006 nominal and real GDP is 10 billion dollars. For 2007, the nominal GDP is 12 billion dollars as the real GDP is 11 billion. The nominal growth rate does not help us in determining the true development in the result as they have inflation baked into it.

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That is exactly why many economists rely on real GDP to determine the true development rate of the overall economy. Another important ratio that is derived using real and nominal GDP is the GDP Deflator. It can be calculated using the next method: (Nominal GDP / Real GDP) / 100 (changes to %).

The GDP deflator is key because it allows us to measure how much a 12 months over 12 months changes in the base degree of GDP (2006 to 2007 in our example) is due to inflation. The GDP deflator is comparable to the consumer price index in that it measures inflation; however, it has a distinct benefit. CPI measures a fixed basket of goods and services as the GDP deflator considers a much broader variety of goods and services, especially new ones that are presented in to the economy.