The Gross Domestic Product (GDP) describes the total value of all goods and services produced within an economy during a specified period of time - usually, one year. It is used as a measure of the aggregate health of the entire economy.

GDP growth describes how much GDP grows over time. It is a measure used to analyse whether the economy is getting bigger or smaller over time. Economic growth is important as it usually means the welfare the country is increasing.

This post outlines the process involved with calculating the nominal and real GDP using an example of an economy with 2 goods. Moreover, it then shows how to calculate the GDP growth rates using those the calculated values of nominal and real GDP.

Consider the following economy which produces two goods, wine and cheese in the two periods of time.

Year | Price of cheese | Quantity of Cheese | Price of Wine | Quantity of Wine |

2018 | $5 | 2 Blocks | $10 | 4 bottles |

2019 | $12 | 3 Blocks | $17 | 3 bottles |

**Nominal GDP**

Nominal GDP is the total dollar value of all goods and services produced in an economy. There are only two goods, wine and cheese, in our assumed economy. The formula for nominal GDP is as such:

Nominal GDP |

Where is the price of wine, is the quantity of wine, is the price of cheese and is the quantity of cheese.

We could calculate the nominal GDP for the year 2018 as follows:

Nominal GDP in 2018 |

We could also calculate nominal GDP for the year 2019 as follows:

Nominal GDP in 2019 |

**Real GDP**

In this previous example, we saw our nominal GDP increase from $50 to $87 despite the fact that we only have only one additional block of cheese but one less bottle of wine. Most of this increase in GDP was due to prices rising, not because we were producing more output.

When calculating real GDP, we calculate it holding prices constant. This means that we choose a “base year” for prices and calculate GDP using those prices instead of the prices corresponding to the same year (the base can be any year we choose, as long as it’s consistent). In our previous example, we could set 2018 as the base year. We could calculate GDP as follows:

Real GDP in 2018 |

And real GDP for 2019:

Real GDP in 2019 |

In this case, real GDP is smaller in 2019 than it was in 2018. This is in contrast with nominal GDP which was larger in 2019 than it was in 2018.

We could also have calculated real GDP using 2019 as the base year. The calculations for real GDP in each period would be as follows:

Real GDP in 2018 |

And real GDP for 2019:

Real GDP in 2019 |

Again real GDP is higher in 2018 than it is in 2019. However, the values for real GDP are also higher. This is because we used higher base year prices.

Given that real GDP is sensitive to the base year used, it is mostly useful to compare relative output between periods.

**Nominal GDP growth**

Nominal GDP growth is the measure of how much GDP grows from one period to the next. The definition for nominal GDP growth is as follows:

Nominal GDP growth |

We can use our calculations from above to calculate the nominal GDP growth:

Nominal GDP growth |

The nominal GDP growth from 2018 to 2019 was 74%. This

**Real GDP growth**

Real GDP growth is the measure of how much real GDP grows from one period to the next. The definition for real GDP growth is as follows:

Real GDP growth |

The problem is that we have different measures for real GDP depending on what year that we choose as the base year. Let’s calculate the real GDP using both base years.

Real GDP growth with 2018 as base year |

Real GDP growth with 2019 as base year |

And here we have a problem. The measures of real gdp growth depends on the choice of base year that we have chosen. To overcome this problem, we can use chained volume series but that will be left for another post.

The most important lesson from this example is that the increase in nominal GDP can overstate the increase in welfare if the increase in GDP is caused by an increase in the price level, which is known as *inflation. *