The GDP deflator (implicit price deflator for GDP) is a measure of the level of prices in an economy for all new, domestically produced final goods and services. It is a price index that is calculated using nominal GDP and real GDP to measure price inflation or deflation.
Nominal GDP versus Real GDP
The market worth of all final commodities produced in a geographical location, generally a country, is known as nominal GDP, or unadjusted GDP. The market value is determined by the quantity and price of goods and services produced. As a result, if prices move from one period to the next but actual output does not, nominal GDP will vary as well, despite the fact that output remains constant.
Real gross domestic product, on the other hand, compensates for price increases that may have happened as a result of inflation. To put it another way, real GDP equals nominal GDP multiplied by inflation. Real GDP would remain unchanged if prices did not change from one period to the next but actual output did. Changes in real production are reflected in real GDP. Nominal GDP and real GDP will be the same if there is no inflation or deflation.
How is real GDP calculated using price and quantity?
What proportion of the growth in GDP is due to inflation and what proportion is due to an increase in actual output? To answer this topic, we must first examine how economists compute Real Gross Domestic Product (RGDP) and how it differs from Nominal GDP (NGDP). The market value of output and, as a result, GDP might rise due to increased production of products and services (quantities) or higher prices for commodities and services. Because the goal of assessing GDP is to see if a country’s ability to generate larger quantities of goods and services has changed, we strive to exclude the effect of price fluctuations by using prices from a reference year, also known as a base year, when calculating RGDP. When calculating RGDP, we maintain prices fixed (unchanged) at the level they were in the base year. (1)
Calculating Real GDP
- The value of the final products and services produced in a given year represented in terms of prices in that same year is known as nominal GDP.
- We use current year prices and multiply them by current year quantities for all the goods and services generated in an economy to compute nominal GDP. We’ll use hypothetical economies with no more than two or three goods and services to demonstrate the method. You can imagine that if a lot more items and services were included, the same principle would apply.
- Real GDP allows for comparisons of output volumes throughout time. The value of final products and services produced in a given year expressed in terms of prices in a base year is referred to as real GDP.
- For all the products and services produced in an economy, we utilize base year prices and multiply them by current year amounts to calculate Real GDP. We’ll use hypothetical economies with no more than two or three goods and services to demonstrate the method. You can imagine that if a lot more items and services were included, the same principle would apply.
- Because RGDP is calculated using current-year prices in the base year (base year = current-year), RGDP always equals NGDP in the base year. (1)
Example:
Table 3 summarizes the overall production and corresponding pricing (which you can think of as average prices) of all the final goods and services produced by a hypothetical economy in 2015 and 2016. The starting point is the year 2015.
Year 2016
Although nominal GDP has expanded tremendously, how has real GDP changed throughout the years? To compute RGDP, we must first determine which year will serve as the base year. Use 2015 as the starting point. Then, in 2015, real GDP equals nominal GDP equals $12,500 (as is always the case for the base year).
Because 2015 is the base year, we must use 2016 quantities and 2015 prices to calculate real GDP in 2016.
From 2015 to 2016, RGDP increased at a slower rate than NGDP. If both prices and quantity rise year after year, this will always be the case. (1)
What is the formula for calculating the GDP deflator?
The GDP deflator estimates the change in yearly domestic production as a result of changes in the economy’s price rates. As a result, it calculates the change in nominal and real GDP over a given year by dividing nominal GDP by real GDP and multiplying the outcome by 100.
It calculates price inflation and deflation for a given base year. It is not based on a pre-determined basket of products or services, but rather on annual consumption and investment patterns.
How do you compute the GDP deflator and give an example?
Calculation of the GDP Price Deflator The GDP price deflator for the economy would be calculated as ($10 billion / $8 billion) times 100, or 125. As a result, from the base year to the current year, the overall level of prices grew by 25%.
What is the formula for GDP?
Gross domestic product (GDP) equals private consumption + gross private investment + government investment + government spending + (exports Minus imports).
GDP is usually computed using international standards by the country’s official statistical agency. GDP is calculated in the United States by the Bureau of Economic Analysis, which is part of the Commerce Department. The System of National Accounts, compiled in 1993 by the International Monetary Fund (IMF), the European Commission, and the Organization for Economic Cooperation and Development (OECD), is the international standard for estimating GDP.
What is a price deflator for GDP?
The GDP deflator, also known as the implicit price deflator, tracks changes in the prices of goods and services produced in the United States, including those exported to other nations.
Is the GDP deflator equivalent to the price index?
The GDP Deflator was introduced in the last module as an important aspect of our examination of GDP and economic growth. The GDP Deflator is the average price of all products and services that are included in GDP. The GDP Deflator is sometimes known as the GDP Price Index or the Implicit Price Deflator for GDP, although they all refer to the price index that is used to convert nominal to real GDP.
The consequences of inflation, which “inflate” the value of nominal GDP, distort it. By subtracting the effects of inflation, real GDP corrects for this misperception. As a result, real GDP is a more accurate measure of production across the economy. The percent change in real GDP is commonly used to gauge economic growth. Without the GDP deflator, neither of these measurements is conceivable.
Because the GDP deflator includes the prices of everything in GDP, the percentage change in the GDP Deflator is the most comprehensive indicator of inflation available, which is why economists favor it. Unlike the CPI, the GDP deflator does not employ set baskets of goods and services, but instead recalculates what each year’s GDP would have been worth using base-year prices.
Is the GDP deflator the same as the rate of inflation?
The GDP deflator is the difference between the two years’ inflation ratesthe amount by which prices have risen since 2016. The deflator is named after the percentage that must be subtracted from nominal GDP to obtain real GDP.
In Excel, how do you calculate GDP deflator?
Let us consider a simple economy with a nominal GDP of $5.65 million (at current prices) and a real GDP of $4.50 million (at constant prices of the base year 2014) in the year 2019. Calculate the economy’s GDP deflator.
As a result, the GDP deflator for the economy for the year 2019 was 125.56.
GDP Deflator Formula Example #2
Let’s look at some random products, such as product X and product Y. The following data on product production quantity and prices for the previous three years is provided, with 2016 as the base year. Calculate the GDP deflator for the years 2016, 2017, and 2018 using the information provided.
How are real GDP, nominal GDP, and inflation calculated?
In general, real GDP is calculated by multiplying nominal GDP by the GDP deflator (R). For instance, if prices in an economy have risen by 1% since the base year, the deflated number is 1.01. If nominal GDP is $1 million, real GDP equals $1,000,000 divided by 1.01, or $990,099.
What is the formula for calculating the implicit price deflator?
In 2007, the United States’ nominal GDP was $13,807.5 billion, while real GDP was $11,523.9 billion. The implied price deflator was thus 1.198. The implicit price deflator was calculated by multiplying price indexes by 100, and the published value was 119.8.
In the following modules, we’ll look at how output and price levels are determined, and we’ll utilize the implicit price deflator as a measure of the economy’s price level.