Real gross domestic product (GDP) is a macroeconomic measure of the size of an economy adjusted for price changes (that is, adjusted for changes in the value of money: inflation or deflation.) Gross domestic product is defined as the market value of all final goods and services produced in a geographical region, usually a country. That market value depends on two things: the actual quantity of goods and services produced, and their price. The actual quantity of goods and services produced is sometimes called the volume. Therefore:
- GDP = Volume x Price
Often, one is concerned with the volume, not the price. Real GDP is GDP with the price factor held constant, so that it reflects only changes in volume.
If adequate price and quantity data are known, GDP can be found by:
- GDP = ∑ ptqt
- Where p are prices, q are quantities, and t indicates the current year.
Then real GDP can be found by substituting the current-year prices with the prices in some base year.
- Real GDP = ∑ pbqt
- Where b denotes the base year.
If a set of real GDPs from various years are calculated, each using the quantities from its own year, but all using the prices from the same base year, the differences in those real GDPs will reflect only differences in volume.
An index called the GDP deflator can be obtained by dividing, for each year, the GDP by the real GDP. It gives an indication of the overall level of price change (inflation or deflation) in the economy.
- GDP deflator for year t = GDPt / Real GDPt
Nomenclature: The simple GDP figure is sometimes called the "current," "nominal," or "historical" GDP, to distinguish it from the real GDP. The real GDP is sometimes called "constant" GDP because it is expressed in terms of constant prices.
Real GDP growth on an annual basis is the nominal and abnormal GDP growth rate adjusted for inflation and expressed as a percentage. Because Real GDP is adjusted for changes in prices and inflation throughout the year, it can be thought of in terms of 'purchasing power.' As a result, individual purchasing power can be measured by Real GDP per capita, i.e., real GDP divided by the size of the population.
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