But why is Inflation so important?
The GDP figure which does not take into account the inflation is called the nominal GDP. Now suppose the GDP of a country stood at $100 million in 2018. Due to certain factors, the country actually produced the same number of units in all sectors. But due to inflation of 5%, the nominal GDP stood at $105 million.
Hence, to an outsider, it would look like the country’s economy grew by 5% when the reality was that nothing changed. Thus, we used GDP adjusted for inflation to get a clear view of how the country is performing. This is called Real GDP.
Real GDP is always counted with reference to a base year. For example, the base year in the US is 2012 while in India it is 2011-12.
But now you are wondering how different countries can be compared to each other. For example, while India and the UK are close to each other when it comes to the GDP figures, the population figures are totally different.
This is why you use Real GDP per capita to understand how countries are performing. Thus, even though India might have a GDP figure larger than the UK, it is worse off since it has to distribute this number with a larger population.
The GDP per capita is given below:
Note: Visit QuantInsti to see an interactive version of this chart.
Some macroeconomists have gone further and use the purchasing power parity (PPP) for comparing different economies. Purchasing power parity tries to compare similar expenses among different countries.
For example, in the table below, we see that for a similar expense of rent, you have to pay ten times more in country A than B. Thus, the PPP in country A is 10 times country B.
|Type of expense||Country A||Country B|
|Rent for 2 room flat||1000||100|
|Food and groceries||500||50|
Let us move further on the next macroeconomic variable.
Stay tuned for the next installment in which the author will review the Unemployment Rate.
Visit QuantInsti for additional insight on this tutorial:
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