Gross Domestic Product

Real and nominal gross domestic product

When evaluating the macroeconomy, it’s important to distinguish between real and nominal GDP. Let's study those differences.

Nominal Gross Domestic Product

Nominal GDP measures GDP, or total economic activity, at current market prices. It measures the value of all goods and services produced in the economy in terms of the current prices in the economy.

We calculate the nominal GDP by adding the value of total expenditure in the economy through the following formula:

$NominalGDP=C+I+G+(X-M)$

Real Gross Domestic Product

On the other hand, real GDP measures the value of all goods and services produced in the economy whilst considering price changes or inflation. In an economy, prices are likely to change over time. When comparing data over time, it’s important to look at real values to gain a more objective insight.

We calculate real GDP using the following formula:

$RealGDP=\frac{NominalGDP}{PriceDeflator}$

Gross Domestic Product per capita

GDP per capita measures the GDP of a country per person. We calculate it by taking the total value of GDP in the economy and dividing it by the country’s population. This measurement is useful for assessing the GDP output of different countries as population size and population growth rates vary between countries.

$GDPpercapita=\frac{GDP}{Population}$

Gross Domestic Product in the UK

Figure 1 below shows GDP over the past seventy years in the UK. It was equal to around £1.9 trillion in 2020. As we can see, GDP was growing at a steady rate until 2020. We may infer that this drop in GDP in 2020 could be due to the COVID-19 pandemic impacting the supply of labour and increasing unemployment.

Fig. 1 - GDP Growth in the UK. Created with data from the UK Office for National Statistics, ons.gov.uk

Gross National Product (GNP) and Gross National Income (GNI)

As we now know, GDP is the value of all outputs (goods and services produced) in a country over a certain period.

The GDP’s output is domestic. The output includes everything produced in the country, regardless of whether a foreign company or an individual produced it.

On the other hand, in Gross National Product (GNP) and Gross National Income (GNI), the output is national. It includes all income of a country’s residents.

Put in simple terms:

We use this formula to calculate GNP and GNI:

$GNP=GDP+(IncomefromAbroad-IncomeSentAbroad)$

Economic growth and Gross Domestic Product

Economic growth is the sustained increase in the economy’s output over a certain period, usually one year. We refer to it as the percentage change in real GDP, GNP, or the real GDP per capita over a period of time. Thus, we can calculate economic growth with the formula:

$GDPGrowth=\frac{RealGD{P}_{year2}-RealGD{P}_{year1}}{RealGD{P}_{year1}}x100$

For the A-levels, it’s important to understand the difference between a decrease in real GDP growth and a negative real GDP. A decrease in real GDP growth would suggest that the growth rate of a country’s GDP is falling over time, even though the growth rate might still be positive. In other words, it doesn’t imply that the real output is shrinking, it’s just growing at a slower rate.

On the other hand, a negative real GDP would imply that the economy’s growth rate is negative. In other words, the economy’s real output is shrinking. If a country is experiencing a sustained negative real GDP, it could be indicative of a recession.

Purchasing power parity

GDP, GNP, GNI, and GDP growth provide a good basis for understanding how a country’s economy is doing compared to previous years and to other countries. However, if we want to think in terms of economic welfare and living standards, it is important to consider additional metrics like the purchasing power parity (PPP.)

Purchasing power parity is an economic metric used to measure and compare the buying power of different countries’ currencies. It evaluates different countries’ currencies by constructing a standardised basket of goods and analysing how the price of this basket compares between countries. It is usually measured based on a country’s local currency in terms of US dollars (USD).

Purchasing power is therefore determined by the cost of living and inflation in a certain country, whilst purchasing power parity equalises the purchasing power of two different countries’ currencies. This is important because different countries have varying price levels in their economies.

As a result, in poorer countries, one unit of a currency (1 USD) has greater purchasing power when compared with higher-price countries, as the costs of living are lower. PPP and PPP exchange rates allow us to get a more accurate comparison of economic and social welfare across countries because they consider price levels and costs of living.

GDP is an important tool that helps measure total output and income, which allows us to do a basic evaluation of a country’s economic performance. However, it’s also important to consider other economic welfare factors when using it as a comparison tool between different countries’ economic performance.

¹OECD, Purchasing power parities (PPP), 2020.