Real GDP strips out the effect of prices
Definition
Nominal GDP: GDP measured using the prices of the current year.
Real GDP: GDP measured using the prices of a fixed base year, so the effect of price changes is removed.
- If prices rise, nominal GDP can climb even when the quantity produced has not changed at all, which is why it cannot be used to judge growth.
- Real GDP holds prices constant, so a rise in it can only come from producing more.
- Every official growth figure is therefore a real figure, and a question that hands you nominal GDP is asking whether you notice.
- The base year is simply the year whose prices are used, and it is updated from time to time as the pattern of output changes.
The wider difference between real and nominal values is covered in 3.4.1.
Common Mistake
- Do not treat a rise in nominal GDP as growth, because it may mean nothing more than that prices have risen.
- Do not describe real GDP as GDP with inflation added, since removing the effect of price changes is the opposite of adding it.
GDP counts output produced inside the country
- GDP counts production that happens inside a country's borders, whoever owns the firm doing it, so a Japanese owned car plant in Sunderland counts in UK GDP.
- It is a flow measured over a period rather than a stock held at a moment, and it is published quarterly as well as annually.
- Only output that is bought and sold is counted, so unpaid housework and unpaid caring are left out even though they have real value.
- Nothing is subtracted for the pollution or the resources used up in producing the output, so the figure records the gain without the cost.
Note
- GDP measures output, not wellbeing, so two countries with the same GDP per capita can offer very different lives.
- Treat it as a useful but incomplete guide, and say so whenever you draw a conclusion from it.
GDP per capita tracks output for each person
- Total GDP shows the size of an economy while GDP per capita shows how much output there is for each person, and the two can move in opposite directions.
- That happens when the population grows faster than output, so the same total is shared between more people.
- GDP per capita is therefore the better measure for a question about living standards, and total GDP the better one for a question about economic size.
- Being an average, GDP per capita still says nothing about how that output is shared between people.
Self review
- What does GDP measure?
- Explain the difference between real and nominal GDP.
- Why is real GDP used to measure economic growth?
- Give two things GDP leaves out of its count of output.
- Why can real GDP rise while real GDP per head falls?
