Part 1. real goods, employment, and business management indicator
Nominal GDP and Real GDP
If GDP has increased in a given year, there are possibilities that either ① total output has increased, ② the prices of output have risen, or ③ both have occurred compared to the previous year. To accurately measure how the total quantity of goods and services produced in the national economy changes over time (economic growth), it is necessary to separate the quantity and price factors. Accordingly, GDP is estimated by distinguishing between nominal GDP and real GDP.
① If total output has increased, it means that the quantity of goods and services produced domestically has expanded.
② If the prices of output have risen, it indicates inflation or an increase in the price level. When the prices of output increase, GDP can also increase, even if the quantity of goods and services produced remains the same or grows at a slower rate.
③ In some cases, both factors may contribute to GDP growth. For instance, if both total output increases and the prices of output rise simultaneously, GDP reflects the influence of both factors.
The distinction between nominal GDP and real GDP is important. Nominal GDP is calculated at current prices and reflects price factors. In contrast, real GDP measures the quantity of goods and services produced based on the prices of a specific base year, excluding price factors, to provide a more accurate representation of economic growth and to remove the impact of inflation.
Concepts of nominal GDP and real GDP
Gross Domestic Product (GDP) at current prices, also known as nominal GDP, is the value of final goods and services produced within a country’s borders calculated using the prices prevailing during the period in which those goods and services were produced. On the other hand, real GDP is measured using the prices from a base year and is sometimes referred to as GDP at constant prices.
Currently, real GDP in many countries, including South Korea, is estimated using a chained-weighted method recommended by the System of National Accounts (SNA). The chained-weighted method calculates real GDP by multiplying the nominal GDP amount of the base year by a chain volume index. This method, instead of continually applying the prices of the base year, takes into account changes in relative prices between goods and services, considering factors like technological innovations and shifts in relative prices among products. As a result, the chained-weighted method is considered to better reflect the economic reality in real GDP calculations and is seen as an improvement over traditional methods.
The difference between nominal and real GDP
Nominal GDP is used to assess the size and structure of a country’s economy, while real GDP is used to analyze the overall economic activity, including economic growth and business cycles.
In the case of South Korea in 2017, the nominal GDP was 1,730.4 trillion won, showing a 5.4% increase compared to the previous year, while the real GDP was 1,556.0 trillion won, indicating a 3.1% increase from the previous year. The reason why the nominal GDP growth rate (5.4%) was 2.3 percentage points higher than the real GDP growth rate (3.1%) in 2017 is due to a general increase in prices by 2.3%. This means that a portion of the nominal GDP growth can be attributed to inflation.
The fact that the nominal GDP is 11.2% larger than the real GDP in 2017 reflects the overall price level of the national economy, which increased by 11.2% compared to the base year, 2010. This difference between nominal GDP and real GDP can be explained by changes in the GDP deflator. The GDP deflator is calculated by multiplying nominal GDP by 100 and then dividing it by real GDP. In the base year (2010), nominal GDP and real GDP are equal, so the GDP deflator is 100.
In summary, the difference between nominal GDP and real GDP is explained by changes in the overall price level of the economy, as measured by the GDP deflator, which reflects the impact of inflation or deflation on economic growth and the size of the economy.
| Year | Nominal GDP (trillion won) | Real GDP (trillion won) | Nominal GDP Growth Rate (%) | Real GDP Growth Rate (%) | GDP Deflator |
|---|---|---|---|---|---|
| 2016 | 1641.8 | 1509.8 | - | - | 108.7 |
| 2017 | 1,730.4 | 1,556.0 | 5.4 | 3.1 | 111.2 |
- The nominal GDP growth rate in 2017 (5.4%) was higher than the real GDP growth rate (3.1%) due to a 2.3% increase in overall prices.
- The difference between nominal and real GDP is explained by changes in the GDP deflator, which measures changes in the overall price level of the economy.
Real GDP Estimation Method
Fixed-Weighted Method:
- Uses the prices or weights from a specific base year and applies them consistently over time.
- Calculates the real GDP of each year by multiplying the production quantity of that year with the prices from the base year.
Chained-Weighted Method:
- Recommends using chained-weighted method by the System of National Accounts (SNA) since the 1990s.
- Takes into account the continuous changes in relative prices and quantity systems by creating a chain volume index from the base year to the estimation year.
- Reflects changes in relative prices and the appearance and disappearance of new products.
Advantages of Chained-Weighted Method:
- Better reflects economic reality, especially in the face of technological innovations and shifts in relative prices.
- Provides a more accurate representation of the economy’s actual growth and size.
- Recommended by SNA and widely adopted by advanced economies, including South Korea.
Disadvantage of Chained-Weighted Method:
- Non-additivity: Chained-weighted method does not satisfy the additivity property, meaning that the sum of real GDP components may not match the total real GDP. This is in contrast to the fixed-weighted method.
Despite its non-additivity drawback, the advantages of the chained-weighted method have led to its adoption in many countries, including South Korea, for estimating real GDP. Additionally, the use of chained-weighted methods is expanding to other economic indicators like consumer price indices and producer price indices.
