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What is the 'GDP Price Deflator'

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

BREAKING DOWN 'GDP Price Deflator'

The GDP price deflator measures the extent of price level changes, or inflation, within the economy. This includes the prices of goods and services from businesses and the government as well as any purchased by consumers. The calculation of the deflator shows how changes in the base year's GDP rely upon price level changes. 

The GDP price deflator is also known as the GDP deflator or the implicit price deflator. 

Why is the GDP Deflator Important?

It is important because an economy's nominal GDP differs from its real GDP in that nominal GDP includes inflation, while real GDP does not. As a result, nominal GDP will often be higher than real GDP. 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.

How to Calculate the GDP Price Deflator

In order to find the GDP price deflator, you'll need to use the following formula:

                            GDP Price Deflator = (Nominal GDP ÷ real GDP) x 100

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, which equals 125.

This means that the aggregate level of prices increased by 25 percent 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 vs. the Consumer Price Index

There are indexes other than 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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