A super simple thread to help everyone understand Gross Domestic Product (GDP), Real GDP and Nominal GDP.
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#GDP #Economy #financialliteracy

1. Understanding the basics

Can you answer this?
What is the total of a chair and a table?
Sounds weird right?
Okay can you answer this?
What is the total of Rs. 400 (value of a chair) and Rs. 1000 (value of a table) ?

It would be Rs. 1400. Well that was an easy peasy question.
You see when I asked you to add two goods (a chair and a table) you were not able to do so. But when I asked you to add the numbers you did it easily.

To make the things comparable we need a common unit and hence we have to convert the goods and services into their monetary value.
This is how we calculate the total production made by a country.

2. Breaking down GDP

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in one year.

Gross would mean we are considering the amount of goods without deducting depreciation.
a. So we have- Gross= Net + Depreciation.
b. Example-I have purchased a Furniture worth Rs. 10,000 and it depreciated by Rs.1,000.

So, the Net Value shall be Rs. 9,000 and the Gross Value shall be Rs. 10,000.

Domestic would in the easiest language mean within the country.
This has to be differentiated with National which includes Net factor income from abroad.

National income includes the income of normal residents only (irrespective of their place of earning), whereas, domestic income includes the income of both residents and non-residents (but, within the domestic territory of the country).

So we have- National= Domestic + Net factor income from abroad.
Example 1- Income earned by Chris Gayle during IPL shall be included in Domestic income (as it is earned in India). This however won’t be included in National Income as it is not earned by a resident.

Example 2- Income earned by Tata Motors by selling their cars in China won’t be included in the domestic income ( as it is not earned in India). This however would be included in National Income as it is earned by a domestic company registered in India.

Product means to multiply.
Simply put I made 100 chairs in one year and the price per chair is Rs. 400.
Hence my total contribution to the country’s GDP would be the product of 100 and 400 i.e. Rs 40,000.

3. What is Real GDP and Nominal GDP?
‘Raju’ is a manufacturer and in the year 2017 he manufactured goods worth Rs.10,00,000.
In the next year, 2018 he manufactured goods worth Rs.20,00,000.

Now, if we analyse the numbers and compare them we would prima faciely jump to the conclusion that Raju has contributed more to the country’s GDP and has doubled his contribution from Rs.10 lakh to Rs.20 lakh.

But, there is a catch here.
Let me tell you the details of the year 2017 and 2018.

1. In 2017, Raju manufactured 10,000 units. The price per piece was Rs. 100. Hence, the contribution to GDP was Rs.10 lakh.
2. In 2018, Raju manufactured 5,000 units. The price per piece was Rs.400. Hence, the contribution to GDP was Rs. 20 lakh.

Now, we can clearly conclude two things here by comparing the 2017 and 2018 numbers:
1. Production declined: The production in 2018 is only half the production in 2017.
2. Price increased: The price per unit multiplied 4 folds from Rs.100 to Rs.400 from 2017 to 2018.

Hence, the primafacie conclusion that Raju’s performance improved from 2017 to 2018 is wrong.
In fact,
1. The production declined which is actually not a sign of growth but that of a slowdown.
2. The price increase is dangerous as it is a sign of Inflation.

So, to sum up, when we compare the numbers of two years, the numbers can be deceptive due to increase in price. Hence, in true sense we would be able to comment whether or not the economy is growing when we keep the prices constant.

In such case, the only thing impacting the GDP would be the production of goods and rendering of services.
Hence, we have two different concepts: Real GDP and Nominal GDP.

Real GDP: Here, the prices are kept constant. ‘Real’ GDP as the name indicates helps us in understanding if or not the economy is moving ahead and growing in real sense.

Normally a base year is considered and the prices every year are kept at the level of base year. In the example discussed earlier, the Real GDP shall be Rs.5 lakh (5000 units multiplied by Rs.100 per unit). Which means, the contribution of Raju has declined.

Nominal GDP: Here, the prices are the current market prices. ‘Nominal’ GDP as the name suggests, is calculating the GDP nominally i.e. only for the sake of it. It can be deceptive as discussed earlier. In the example discussed, the Nominal GDP is Rs.20 lakh.

The End.
This was originally posted on Quora by me. Here's the link: https://qr.ae/pNKIi7 
@Dinesh_Sairam, @dmuthuk, @finbloggers