What is the Real GDP Formula?

What is the Real GDP Formula?

Definition

Real gross domestic product (GDP) is calculated by dividing nominal GDP by the deflator:
Real GDP = Nominal GDP/Deflator
Where:
Nominal GDP is the GDP in current dollar terms. This implies that no adjustment for the impact of inflation or deflation has been made.

The deflator is the factor by which the nominal GDP is divided to arrive at the real GDP. In the U.S., the deflator for calculating real GDP is periodically issued by the Bureau of Economic Analysis, which is a part of the United States Department of Commerce.

What does real GDP formula mean?

GDP measures the total economic output of a country in dollar terms. It is an important measure of the health of a country’s economy. A growing GDP indicates that the economy is expanding and that a greater amount of goods and services are available to the people.

GDP can be expressed in nominal or in real terms. Nominal GDP is the total sum of goods and services at current dollar values. Real GDP, on the other hand, measures total economic output after adjusting for price changes. In other words, the impact of inflation or deflation is also considered.

It follows that in an inflationary situation, nominal GDP will be greater than real GDP. Conversely, when prices are falling, the reverse will be true.

The GDP formula is used to convert nominal GDP into real GDP.
Real GDP = Nominal GDP/Deflator
The deflator used in the GDP formula adjusts nominal GDP to make it comparable to a certain base year. If, for example, the inflation rate is 10% in a year, the deflator would be 1.1.

So, if nominal GDP in Year 1 was $10 trillion and in Year 2 it was $11 trillion, the real GDP can be calculated by using the real GDP formula.

Real GDP = $11 trillion/1.1
Real GDP = $10 trillion.

This simple illustration shows that while nominal GDP has grown by 10%, the entire gain was due to inflation. By applying the real GDP formula, we have worked out that the inflation-adjusted GDP is $10 trillion.

Example of real GDP formula

According to data issued by the Federal Reserve Bank of St. Louis, the annualized GDP of the U.S. for the first quarter of 2018 was $19.965 trillion. This figure is expressed in current dollars. It is, therefore, the country’s nominal GDP.

It can be converted to real GDP by dividing it by the deflator, which is 1.14837. This figure assumes a base year of 2009 when the price index is considered to be 100. In Q1 2018, the index stands at 114.837. Real GDP Formula
The real annualized GDP in Q1 2018 is:
Nominal GDP/Deflator
$19.965 trillion/1.14837
Real GDP (based on 2009 dollars) = $17.386 trillion.

Summary

The real GDP formula allows nominal GDP to be converted into real GDP by using a deflator to account for price changes. Remember that real GDP is always expressed with reference to a certain base year.