Read further to learn the following:
- How to find real GDP (real GDP calculation formula);
- What is the real GDP definition, and;
- What is the difference between nominal GDP and real GDP.
Moreover, you can find answers to related questions in the FAQ section, such as "How to calculate real GDP with a base year?" and "How to calculate real GDP per capita?".
What is real GDP?
The real GDP (real gross domestic product) measures the economic output that filters out the effects of changes in the general price level. That is, the real GDP is the inflation (or deflation) adjusted nominal GDP.
Since a considerable part of changes in the nominal GDP may be due to changes in the general level of prices, the real GDP is a better economic indicator for estimating the actual growth in output than the nominal GDP.
Comparing nominal GDP vs. real GDP
The best way to compare nominal vs. real GDP is to look at their components. While the value of nominal GDP contains both price changes and economic growth, the real GDP accounts for only the growth.
Therefore, the difference between nominal GDP and real GDP is the result of the price level adjustment. Now, let's see how to find real GDP using a simple real GDP calculation formula.
How do I calculate real GDP from nominal GDP?
To calculate real GDP from nominal GDP, you need to:
- Divide the nominal GDP by a price index.
- Typically the GDP deflator is used for that purpose, since it is the most comprehensive measure of the changes in the general price level in a given economy.
- We can write the real GDP formula in the following simple way:
Real GDP = Nominal GDP / GDP deflator
How do I calculate price index with real and nominal GDP?
To calculate the price index from the real and nominal GDP, you need to divide the nominal GDP by the real GDP. The resulting index is called the GDP deflator.
How do I calculate growth rate of real GDP?
The growth rate of real GDP is typically measured as the percentage change in a country's GDP between two consecutive years. Therefore, to compute the GDP growth rate, you need to have the real GDP of two years (base year and current year) and proceed with the following formula:
GDP growth rate = (current - base) / base
current- The current year's real GDP; and
base- The base year's real GDP.
How do I calculate real GDP per capita?
To calculate the real GDP per capita, you simply need to divide the real GDP for a given year by the population in a given country. The real GDP calculation formula is the following:
real GDP per capita = real GDP / population
How does monetary policy affect real GDP?
In the case of an expansionary monetary policy, the traditional interest rate channel of the monetary transmission mechanism operates in the following way:
- Monetary policy lowers interest rates (i.e., federal funds rate) and increases loanable funds.
- Real interest rates decrease.
- Aggregate demand increases (i.e., higher investment and consumption due to lower borrowing cost).
- Real output increases.
How to invest during GDP expansion time?
GDP expansion makes equity markets rise. Here I will share one main concept and two ways of investing for such times:
First, you should look for companies with growing free cash flow (FCF). FCF is the cash available for expanding the business. Your goal is to pick companies in the best position to benefit from more consuming demand by creating new products or acquiring new companies.
Second, one of the ways you could invest is by buying futures contracts that negotiate stock indexes. During GDP expansion times, stock indexes like the SP500 rise in value. Having a long position in such future contracts could make you earn extra profits.
Third, the second investing way is by choosing companies that trade at a price below its fair value, meaning they are at a discount. One of the methods for finding our cheap but valuable companies is the Graham number.