Real GDP is calculated by dividing nominal GDP by the GDP price deflator and multiplying by 100 when the deflator is an index. This converts current-price GDP into the value of output at base-year prices.
Formula:
Example:
Suppose nominal GDP is $550 billion and the price deflator is 110:
This means the economy's output, valued using base-year prices, is $500 billion. The higher nominal figure reflects both actual production and the increase in the average price level. A deflator of 110 means the general price level is 10% higher than in the base year, not 110% higher.
Common misconception: Don't divide the deflator by 100 and then multiply by 100 again, that's redundant. Just apply the index formula directly as shown above.
If the deflator is given as a decimal (e.g., 1.10 instead of 110), drop the ×100:
Key point: The base year always has a deflator of 100 (or 1.00 in decimal form). A value above 100 indicates a higher price level than the base year; a value below 100 indicates a lower price level.
Key point: The base year always has a deflator of 100 (or 1.00 in decimal form). A value above 100 indicates a higher price level than the base year; a value below 100 indicates a lower price level.
Exam Technique
For a calculate question, write the formula, substitute the data, show each step, and include currency units. Check whether the deflator is an index or decimal before calculating. In evaluation, use real GDP rather than nominal GDP when assessing actual economic growth, because nominal GDP may increase only due to inflation. This distinction is essential when comparing economic performance across years.
Do not confuse the GDP price deflator with a measure of real output itself: it is a price index used to remove inflation from nominal GDP.
