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The GDP price deflator adjusts gross domestic product by removing the effect of rising prices. It shows how much an economy’s GDP is really growing.

The formula looks like this:

A nation’s gross domestic product is the total value of the goods and services it produces over a period of time.

A nation’s nominal GDP is the total value of goods and services it produces over a period, without adjustment for inflation.

A nation’s real GDP is its nominal GDP adjusted for inflation, which reflects the real amount of goods and services produced.

Say Small Country has a nominal GDP in 2012 of \$1 million. The quantity of the goods it produces increases from 2012 to 2013, but so do the prices. The nominal GDP for 2013 is \$1.155 million. We want to know how much of that increase in GDP is due to the increase in prices.

We get the real GDP for 2013 by taking the quantity of goods and services produced in 2013, and multiplying it by 2012’s prices. That equals \$1.1 million.

The GDP price deflator is 105. That tells us prices increased 5 percent between 2012 and 2013.

The consumer price index measures the average change over time in prices consumers pay for a fixed basket of goods and services.  The GDP price deflator is not based on a fixed basket, so it reflects changes in consumption or the addition of new goods or services.

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