Question

If we want to assess changes in the real economic activity in an economy, why do we use changes in real GDP for finding an answer, instead of changes in nominal GDP?

Answer 1

The objective of measuring economic activity is to evaluate how much the production capacity of the nation has grown in terms of goods and services produced .

Nominal gdp = current price * current output

Real gdp = current output * prices in base year

So nominal gdp can increase on account of increase in price or output or both whereas real gdp will show an increase only incase of an increase in output.

Eg: 2018 base year where price = 100 , output = 50 , so nominal gdp and real gdp = $5000

In year 2019 , price = 110 , output = 50, nominal gdp = $5500 whereas real gdp will be the same = 100*50 = $5000

Although nominal gdp has increases but this does not mean welfare of people has improved as there has been no change in the output . The output Level has remained same in 2018-19 . It is only when the output would increase such that per capita consumption increase would the welfare of people increase . So true measure of welfare is real gdp and not nominal gdp .