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National Income Accounting
Real GDP and Nominal GDP. GDP is broadly sum total of value of goods and services produced within domestic (economic) territory of a country in a particular year. GDP can be measured in two ways — at current prices (prices of the year in which goods and services have been produced) or at constant prices (prices prevailing in the base year).
(i) Nominal GDP. When goods and services included in GDP are valued at current prices, i.e., prices prevailing in the year for which GDP is being measured, it is called nominal GDP. For example, Nominal GDP of 2010 is the value of output produced in 2010 calculated at the market prices prevailing in 2010. In short Nominal GDP values current year's output in an economy at current year prices.
(ii) Real GDP. When GDP is measured at constant (fixed) prices, i.e., prices of the base year, it is called real GDP. Constant prices refer to prices prevailing in some carefully chosen year which is treated as base year. It is a normal year devoid of price fluctuations. In short Real GDP values current year output in an economy at base year prices (i.e., constant prices). Real GDP is the indicator economic welfare. In India presently 2004-2005 is taken as base year for constant prices.
Can Nominal GDP be ever less than Real GDP? Yes, when prices in current year are less than the prices in base year.
Significance of distinction. Real GDP truely reflects the level of economic growth whereas nominal GDP does not. Its reason is that nominal GDP is affected by two factors, namely, change in physical output and change in prices whereas real GDP is affected only by change in physical output. If current market prices rise by 100%, nominal GDP will also rise by 100% even though physical output remains the same. On the contrary, real GDP can change only when physical output changes because prices are fixed or constant. Thus, real GDP is a better and more reliable index of growth of an economy.
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