To determine the correct statement regarding Real GDP, let's understand what Real GDP actually represents and how it is calculated.
1. Nominal GDP: This is the market value of all final goods and services produced in a country within a specific time period, evaluated at current market prices. It does not account for changes in the price level (inflation or deflation).
2. Real GDP: This accounts for changes in the price level and provides a more accurate reflection of an economy’s size and how it’s growing over time. It eliminates the effects of inflation or deflation.
To calculate Real GDP, we use the following relationship:
[tex]\[ \text{Real GDP} = \frac{\text{Nominal GDP}}{\text{Price Index}} \][/tex]
The price index is often adjusted to reflect a base year, providing a constant price perspective.
Given this information, let's evaluate the given statements:
1. Real GDP is nominal GDP subtracted from the price index.
- This statement suggests that Real GDP would be calculated as:
[tex]\[ \text{Real GDP} = \text{Nominal GDP} - \text{Price Index} \][/tex]
- This is not the correct way to calculate Real GDP. Subtracting the price index from nominal GDP does not appropriately account for changes in price levels and would not yield an accurate measure of Real GDP.
2. Real GDP is nominal GDP added to the price index.
- This statement suggests that Real GDP would be calculated as:
[tex]\[ \text{Real GDP} = \text{Nominal GDP} + \text{Price Index} \][/tex]
- Adding the price index to nominal GDP again does not provide a method to properly adjust for price level changes. This method also fails to respond to the inflation/deflation adjustment required for Real GDP.
Based on the correct method for calculating Real GDP, neither of the provided statements accurately describe how Real GDP is derived. Therefore,
Both statements regarding Real GDP are incorrect.
The key takeaway is that Real GDP is calculated by adjusting nominal GDP for changes in the price level (inflation or deflation) using division by the price index, and not by simply adding or subtracting the price index.
