Introduction to GDP Deflator
GDP deflator or an implicit price deflator is an indicator of the impact of inflation on GDP in an economy, or it merely notes the price changes in an economy in one year. GDP deflator gets its name from the process of calculating the value of price change as reflected in real and nominal GDP of the country.
Understanding GDP Deflator
GDP deflator is an essential measure in an economy that helps compare the rise in price levels of goods and services between years. Unlike Consumer Price Index (CPI), GDP deflator can be compared between several periods of time without the use of base year as its constant, nor use a specific basket of goods. GDP Deflator is flexible. But like the CPI, GDP Deflator does have a base value and that equals to 100.
GDP Deflator value is calculated using the following formula:
GDP deflator = (Nominal GDP / Real GDP) * 100
Nominal GDP refers to the current prices in the market whereas Real GDP measures the actual cost that went into producing the product. Nominal GDP is calculated using that year’s prices while Real GDP is calculated using the base years prices.
Highlights of GDP Deflator
GDP deflator’s flexibility allows the study of various economic phenomena, expenditure pattern study and behavioural changes in demand and consumption of the people. This is possible because the deflator is not based on a particular sect or basket of goods. It changes with the spending patterns.
GDP Deflator is a price index (PI) that focuses on showing the impact of inflation or deflation on the current prices in the economy, thereby showing how dependent and relative GDP is to price changes.
GDP deflator might not share a considerable difference with CPI, but it is still a valuable measure to calculate, since some countries take the effects of inflation into serious consideration.
When Nominal GDP is divided by GDP Deflator and then multiplied by 100, we get the value of the real GDP, thereby deflating the exaggerated value to the true value of the production of goods.