Measuring Economic Growth Through Real Gross Domestic Product
Expert reviewed • 14 August 2024 • 6 minute read
Economic growth is a key indicator of a country's economic health and performance. Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country in a given period. GDP can be measured in nominal terms, which is the value at current prices, or in real terms, which is adjusted for inflation.
What is the Difference Between Real GDP and Nominal GDP?
Nominal GDP measures the value of all goods and services produced at current prices without adjusting for inflation. While it shows the economic activity's current value, it can be misleading during periods of inflation or deflation. Conversely, Real GDP is the total value of all final goods and services produced within a country's borders over a specific time period, adjusted for inflation. It's the primary measure used to gauge the size and growth of an economy.
As such, we can assume that nominal GDP will often display a higher value than real GDP. This is affirmed by the following graph.
From the graph, we can see that nominal GDP growth in Australia has been consistently larger than real GDP growth, as of 2010 onwards.
Calculating and Understanding Real GDP Growth
Real GDP growth is a crucial measure of economic performance. It indicates how much an economy has grown or shrunk after adjusting for inflation. Positive real GDP growth signifies economic expansion, while negative growth indicates contraction. As such, a formula can be used to calculate the economic growth rate of an economy using Real GDP:
This gives us the percentage change in Real GDP from one period to another.
Interpreting Real GDP Growth
When analysing Real GDP growth, we must consider multiple components including the following:
- Positive vs. Negative Growth: Positive growth indicates economic expansion, negative growth suggests contraction or recession.
- Comparison to Potential Growth: Actual growth should be compared to an economy's potential growth rate.
- Sectoral Analysis: Overall GDP growth can mask growth variations in different economic sectors. For example, while the mining industry experiences large amounts of economic growth, the agricultural industry may experience slow economic growth.
What are the Limitations of Real GDP as a Growth Measure?
Despite its widespread use, Real GDP has several limitations as a measure of economic growth:
- It often fails to fully capture quality improvements in products and services
- It excludes significant non-market activities such as household work
- Real GDP doesn't reflect income distribution within an economy, potentially masking inequality issues
- It falls short in accounting for environmental degradation or resource depletion, which are crucial factors in sustainable development