What is the correct relationship between real growth rate, nominal growth, and inflation rate?

• A. Real growth rate = nominal growth minus inflation rate.
• B. Real growth rate = inflation rate minus nominal growth rate.
• C. Real growth rate = nominal growth rate plus inflation rate.
• D. Real growth rate = nominal growth rate divided by inflation rate.

Answer: (A)

This question checks understanding that real growth removes the effect of rising prices to show the true increase in output. Nominal growth reflects growth in current dollars, including any price increases. Inflation is the rate at which prices rise. To see how much actual production grew, you subtract inflation from the nominal growth rate. For small rates, this subtraction is a good approximation: if nominal growth is 5% and inflation is 2%, real growth is about 3%. The exact relationship, if you want precision, is real growth = (1 + nominal growth) / (1 + inflation) − 1, which reduces to nominal − inflation when the rates are small. So the correct relation is real growth rate = nominal growth rate − inflation rate. If inflation outpaces nominal growth, real growth can be low or even negative.