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What is the 'GDP Price Deflator'

GDP price deflator is an economic metric that accounts for inflation by converting output measured at current prices into constant-dollar GDP. This specific deflator shows how much a change in the base year's GDP relies upon changes in the price level. The GDP price deflator is also known as the "implicit price deflator."

BREAKING DOWN 'GDP Price Deflator'

The GDP price deflator is an economic measure of inflation and is derived by dividing nominal GDP by real GDP, and then multiplying by 100. It is important because an economy's nominal GPD differs from its real GDP in that nominal GDP includes inflation, while real GDP does not. Therefore, the GDP price deflator measures the difference between real GDP and nominal GDP, which can also be used as a measure for price inflation.

If, for example, an economy has a nominal GDP of $10 billion and has a real GDP of $8 billion, the economy's GDP price deflator would be derived as: ($10 billion / $8 billion) x 100, or 125. This means that the aggregate level of prices increased by 25% from the base year to the current year. This is because an economy's real GDP is calculated by multiplying its current output by its prices from a base year. So, the GDP deflator will help identify how much prices have inflated over a specific time period.

The GDP Price Deflator Versus the Consumer Price Index

There are indexes other than the GDP that help measure an economy's inflation. Many of these alternatives are based on a fixed basket of goods. The consumer price index (CPI), for example, measures the level of retail prices of goods and services at a specific point in time. The CPI is considered by some to be one of the most relevant inflation measures in that it reflects any changes to a consumer's cost of living.

However, all calculations based on the CPI are direct, meaning that the index is only calculated on prices already included in the index. The fixed basket used in CPI calculations is static and sometimes misses changes in prices outside of the basket of goods. This makes GDP and the GDP deflator a superior indicator of inflation. Since GDP isn't based on a fixed basket of goods and services, the GDP deflator has an advantage over the CPI: Changes in consumption patterns or the introduction of new goods and services are automatically reflected in the deflator.

This allows the GDP deflator to capture any changes to an economy's consumption or investment patterns. However, the trends of the GDP deflator will often be similar to trends in the CPI.

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