What is GDP Deflator?

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The deflator considers all goods and services that an economy produces or delivers in a year and compares the value of the same items with that of the base year. It differs from a Wholesale Price IndexWholesale Price IndexThe Wholesale Price Index tracks the price movement of products in a set territory and wholesaler jurisdiction. Wholesalers provide, manage, and control commodities, usually commonly traded goods, before they are sent to retailers.read more (WPI), which does not consider the service sectorService SectorThe service sector or tertiary sector refers to one of the portions forming the three-sector model of the economic sector. The businesses in the service industry produce intangible goods in the form of service as output delivering to other businesses or consumers.read more.

Key Takeaways

  • The GDP deflator measures the change in the annual domestic production due to changes in price rates in the economy. It measures price inflation/deflation concerning the specific base year.It measures the change in nominal and real GDP during a particular year calculated by dividing the nominal GDP by the real GDP and multiplying the resultant by 100.It is not based on a fixed basket of goods or services but can be modified yearly depending on consumption and investment patterns.The GDP price deflator of the base year is 100.

GDP Deflator Explained

The GDP deflator tracks the GDPGDPGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more changes with respect to the price fluctuations in the products rather than the total output that an economy produces. Here, the value of the products and services produced and delivered in a particular year are studied and compared with the value of the same items in the base year. In short, it makes the goods and services used for computing the GDP change automatically over time.

Also known as the GDP price deflator or implicit price deflator, the GDP deflator to inflation is a measure that helps an economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more trace the GDP changes per price fluctuations. This way, it enables a nation to determine the extent to which its GDP change depends on the price fluctuations recorded for the grouped items. This change in the price level helps identify the rate of inflation.

Formula

The GDP deflator formula used for calculation is:

Here,

  • Nominal GDPNominal GDPNominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country’s population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more is evaluated using the current market prices. Real GDP indicates an inflation-adjusted measure of all goods and services produced by an economy in a year.

Calculation Example

Let us consider the following example to see how to calculate the GDP deflator:

The data to be used is provided below:

Here, the deflator for 2010 is calculated using the formula mentioned above:

So, the GDP deflator calculation for 2010 is:

The GDP deflator for 2011 to 2015 is calculated in a similar way.

Therefore, the GDP deflator calculation for all years will be as follows: –

The deflator decreased in 2013 and 2014 compared to the base year 2010. This indicates that the aggregate price levels were smaller in 2013 and 2014, exhibiting the impact of inflation on GDP, measuring the price of inflation/deflation compared to the base year.

The implicit price deflator can also be used to calculate the inflation levels with the below formula: –

Inflation = (GDP of Current Year – GDP of Previous Year) / GDP of Previous Year 

Extending the above example, the inflation for 2011 and 2012 has been calculated.

Inflation for 2011

2011 Inflation = [(110.6 – 100)/100] = 10.6%

Inflation for 2012

2012 Inflation = [(115.6 – 110.6)/100] = 5%

The results highlight how the general price of all goods and services fell from 10.6% in 2011 to 5% in 2012.

Uses

Some of the best uses that exhibit the true meaning of a GDP deflator are:

  • It reflects the prices of all domestically produced goods and services in the economy to measure inflation effectively. It includes prices of investment goods, government services, and exports while excluding costs of imports.

  • A deflator automatically indicates important changes in consumption patterns or the introduction of new goods or services. It acts as an effective mode of study to identify patterns and check the inflation rate over the years. In addition, it also identifies the expenditure preference and behavioral patterns of consumers, which helps detect the changes in the demand and consumption cycle.The spending pattern of the population highly influences the GDP deflator.

GDP Deflator vs CPI

While the GDP price deflator considers the value of all goods, products, and services produced in the country, Consumer Price Index (CPI) is based on a limited basket of goods and services. As a result, the latter does not represent the entire economy. 

While CPI data is available monthly, the deflator comes with a quarterly or yearly lag after the GDP is released. Thus, the deflator cannot track monthly inflation changes, which impacts its dynamic usefulness. Nevertheless, let us look at the differences between the deflator and CPI through the comparison table below:

This article has been a guide to what is GDP Deflator. Here, we explain the concept along with the uses, formula, calculation example, and vs CPI. You may also find some useful articles here:

One can find or compute it by dividing the nominal GDP by the real GDP and then multiplying the result by 100. Nominal GDP here is the current price not adjusted to inflation, while the real GDP is the value of the products and services adjusted to the price fluctuations in the market.

As already stated, the deflator measures inflation, exhibited by the prices of the same set of products and services from the current year to the base year.

As the value of nominal and real GDP cannot be negative, the GDP price deflator value is never negative. However, the change in the percentage of change in GDP could be negative or positive. If the percentage change is positive, it indicates inflation. Else, it marks deflation.