How do nominal and real GDP differ?

Nominal GDP measures a country's economic output without adjusting for inflation, while real GDP adjusts for inflation.

Nominal GDP, or Gross Domestic Product, is the total value of all goods and services produced by a country within a specific time period, typically a year, without making any adjustments for inflation. It is calculated by summing up the current market prices of all final goods and services produced in an economy during a given period. This means that if prices increase due to inflation, nominal GDP will also increase, even if the actual production of goods and services hasn't changed.

On the other hand, real GDP takes into account the impact of inflation and provides a more accurate picture of a country's economic growth. It measures the value of economic output adjusted for price changes i.e., inflation or deflation. This adjustment transforms the money-value measure, nominal GDP, into an index for quantity of total output. Therefore, real GDP is a better gauge of the change in the production of goods and services from one year to another.

The difference between nominal and real GDP is crucial in understanding whether the economic growth of a country is due to an actual increase in goods and services, or just a result of price increases. For instance, if nominal GDP has increased by 5% from one year to the next, but inflation has also been 5%, the real GDP growth would be zero, indicating that there has been no actual economic growth.

In summary, while nominal GDP can give a general idea about a country's economic size, real GDP provides a more accurate measure of economic growth by adjusting for inflation. This distinction is vital for economists, policymakers, and students to understand the true health and direction of an economy.