GDP Deflator

The GDP deflator is a tool that measures the gross domestic product (GDP) affected by the change in the price of the products and goods rather than the output of an economy. It helps read the market's expenditure pattern and demand behaviors that directly or indirectly affect a nation's economy.

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 Index (WPI), which does not consider the service sector.

• The GDP deflator equation 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.

The GDP deflator equation tracks the GDP 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 economy 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.

The formula to derive GDP deflator equation is:

Here,

• Nominal GDP 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.

The calculation below would help us understand the concept of GDP deflator equation in better detail. 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 GDP deflator 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 = = 10.6%

Inflation for 2012

2012 Inflation = = 5%

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

The calculation is based on the GDP deflator base year gives analysts, world leaders, and citizens important data points to consider about the state of the economy.Let us discuss some of the best uses that exhibit the true meaning of a GDP deflator through the discussion below:

• 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.

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 formula, how to calculate, and compared it with CPI. You may also find some useful articles here: