What is inflation? What is the difference between real and nominal GDP and why is it important to measure GDP in real growth terms?

Inflation refers to rising price levels. The annual rate of inflation measure the annual percentage increase in price. If the rate is negative (e.g. in Japan), then prices are falling and we are measuring the rate of deflation. Typically, inflation relates to consumer prices (the prices of products consumed); the government published a "consumer price index" (CPI) each month, that is the inflation rate over the last 12 months. A broader measure of inflation is the GDP deflator and measures the inflation rate at which all domestically produced goods and services change.
There is a distinction to be made between nominal and real figures. Nominal figures and those using current prices and interest rate whereas real figure correct for inflation. Therefore, real GDP measure the total economic output of an economy accounting for its annual inflation rate. For example, if GDP in money terms has risen by 5% but the inflation rate if 3%, the real GDP growth is 5%-3% = 2%. It is important to measure GDP growth in real terms because it gives a more realistic and accurate view of economic growth and of the performance of an economy.

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Answered by Constance J. Economics tutor

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