What is real GDP and why does it matter? Real GDP is an economic measurement of the national gross domestic product, which has already been adjusted for inflation and other factors. In simple terms, real GDP pertains to how much the country is worth at today's market exchange rate. Compare this to nominal GDP, which is essentially measures GDP without taking into account inflation, by using current prices. The difference between real and nominal is what is important economically.
Now, one could ask what the importance of real gdp is when we are talking about economics. In the context of economics, we are looking at the whole concept of how money is tied to the value of a nation's resources. When we use real gdp, we are basically calculating the value of the dollar in relation to all of the nation's resources. When inflation sets in, the value of the dollar increases because there are more goods and services being produced for the money. When deflation sets in, the value of the dollar decreases because there are fewer goods and services being produced for the money. This is the basic premise behind the theory of supply and demand.
However, there are more complexities involved in the calculation of real gdp. One of these is how to adjust for deflation. If a nation is experiencing deflation, then it is expected that the gross domestic product, or nDP, will fall because the number of consumers is decreasing. And when economic growth is considered, most economists believe that the real gap should be increasing so as to support the robustness of the economy.
But it is not just nominal gDP that is used in the calculation of real gdp. Most economists use real gdp to calculate the inflation rate. They calculate the rate at which goods and services are purchased in the market by the public. The current price of commodities is also included in this figure. And when it comes to inflation, most economists use the Phillips Curve to estimate the likely effect of inflation on the real gDP, especially since the recent recession.
Although the calculation of real gDP involves many factors, one of the most widely used is the Purchasing Managers Index (PMI). The PMI reflects the buying habits of the private sector that is characteristic of an economy. If the index rises, then it is considered to indicate healthy inflation. Many economists base their estimates on the Purchasing Managers Index and, as they say, “a high measure of inflation is associated with high levels of employment and rising standards of living.”
However, there are some who dispute the notion that inflation is proportional to real gDP growth. They argue that since most economies have higher inflation than they have gross domestic products, then the correlation is irrelevant. On the other hand, the existence . . . . . . of price differences do not mean that inflation is neither beneficial nor harmful to a nation. Whether a nation is experiencing an economic slump or is already at the brink of a financial abyss, its central bank needs to intervene to correct the discrepancies to ensure that the economy adjusts to the changes.