Nominal GDP and Real GDP:

1. Nominal GDP or GDP at Current price – When GDP is estimated on the basis of price of the same year, it is called Nominal GDP.

2. Real GDP or GDP at Constant price – When GDP is estimated, based on the price of base year, it is called real GDP.

GDP deflator (Price Index)

Definition: GDP Deflator is one measure of overall price level. It measures the average level of prices of all the goods and services that make up GDP.

GDP Deflator or price index= Nominal GDP/Real GDP *100

Example:

If Nominal GDP is Rs 21000 Cr. and Real GDP is Rs 18000 Cr. Find GDP Deflator.

Ans: GNP Deflator = ₹116.67

 Difference between Nominal GDP and Real GDP?

Which is better Nominal GDP or Real GDP?

Real GDP is better because:

  • It helps in determining the effect of the increased production of goods and services as it is affected by change in physical output only. On the other hand, Nominal GDP can increase even without any increase in physical output.
  • Real GDP is better measure to make periodic comparison in the physical output over different years.
  • Real GDP facilitates international comparison of economic performance across the countries.

GDP and Welfare

We generally think that the increase in GDP is good. Increasing GDP is usually considered as one of the Chief goals of government's macroeconomics policy.

Because some serious problem arises when we try to use GDP as a measure of happiness or well-being, we now point out some of the limitations of GDP concept as a measure of welfare.

1. Distribution of GDP - GDP does not take into consideration the income distribution in an economy i.e. gap between rich and poor.

It may be possible that a large part of goods and services are consumed by rich. So, the welfare of the people may not rise as much as the rise in GDP.

2. Change in Price – If GDP is increasing due to increase in price rather than the increase in production, and then it will not be a reliable index of economic welfare.

3. Non-Monetary Exchange – GDP includes only those activities which are in direct monetary terms, so those activities like kitchen gardening which are non – monetary exchanges are not included in GDP due to non - availability of data. However, these activities contribute to economic welfare.

4. Externalities – Externalities refers to those harms or benefits for which a firm is not paid or penalised. It is of two types:

  • Positive Externalities – These are the activities which result in benefits to others is termed as positive externalities. For example – Gurudwaras provide free langar for everyone. It increases the welfare of society.
  • Negative Externalities – The activities which results in harm to others are termed as negative externalities. Smoking in public will make people smoke passively It reduces the welfare through a negative effect on health.

GDP does not take these externalities into account.

5. Rate of Population Growth – GDP also does not take into account the rate of growth of population i.e. if GDP is increasing due to increase in population.  If the rate and growth of population are greater than the rate and growth of GDP, then it will decrease per - availability of goods and services which would adversely affect economic welfare.