Explanation of Nominal GDP:

The gross, domestic product (GDP) is the total market value of all the final goods and services produced within an economy in a given year. When all the components of GDP are valued at their current prices in the market, it is called Nominal Gross Domestic Product. Nominal GDP measures national income ruling at the time and thus takes no account of inflation.

In many applications of macro-economics, the nominal GDP is not considered a measure of growth and welfare. If we use the nominal GDP to measure growth of the economy, we will be misled into thinking that production has grown. What all has really happened is a rise in the price level. The standard of living of the people will increase only if (i) the economy produces larger quantity of goods than the previous year and (ii) the goods are sold at normal prices in the market.

The economists while studying the changes in the economy need a measure of output which shows an actual increase in production of goods and it is not affected by changes in their prices. To get this problem solved, the economist use a measure called Real GDP.

Definition and Explanation of Real GDP:

Real Gross Domestic Product (Real GDP) is the production of goods and services valued at constant prices. It is also defined as GDP adjusted for price changes. It is a measure of output that reflects actual income in production, separate and apart from any price changes that may have occurred in the economy during the year.       

Nominal GDP is GDP evaluated at current market prices. Therefore, nominal GDP will include all of the changes in market prices that have occurred during the current year due to inflation or deflation. In order to abstract from changes in the overall price level, another measure of GDP called real GDP is often used. Real GDP is GDP evaluated at the market prices of some base year. For example, if 2005 were chosen as the base year, then real GDP for 2010 is calculated by taking the quantities of all goods and services purchased in 2010 and multiplying them by their 2005 prices