GDP Deflator: Calculation and Importance

The GDP price deflator is also known as the GDP deflator, which measures the changes in the prices for all goods and services produced in the economy. Another name for GDP deflator is known as implicit price deflator. 

The Gross Domestic Product (GDP) measures the total output of goods and services. As the GDP rises and falls, the metric doesn't factor the impact of inflation or the rising prices into its results. It's an essential measure in an economy that helps compare the rise in the price level of goods and services between the years.

The GDP price deflator is there to show the effect of the price changes on a country's GDP. It does this in two steps: first by establishing a base year and secondly by comparing the current prices to the base year's prices. 

GDP price deflator shows how much a change in the GDP depends on the changes in the price level. It shows the extent of the price level changes and inflation within the economy by tracking prices everyone pays in the country- people, businesses, and government.  

The GDP deflator is a price index that focuses on showing the impact of inflation and deflation on the current prices in the economy. This, in turn, shows how dependent and relative GDP is on the price changes. 

GDP Price Deflator in India 

The GDP price deflator is calculated annually in India and released annually. In 2020, the GDP deflator in India was reported as 146. This deflator measures the changes in prices for all the goods and services in the Indian economy. The base year for the GDP price deflator is 2012. 

The GDP price deflator is called a comprehensive tool because each year you calculate the set of all the goods that were produced domestically by the market value of the total consumption of each good. This helps to show the new expenditure patterns which are seen in the deflator. 

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GDP Price Deflator Example 

In the ordinary sense, GDP is usually expressed in nominal GDP, which shows the country's total output in dollar terms. Before knowing the working of the GDP price deflator, you need to see how the prices impact the GDP figures from one year to another. 

For example, India produced  $15 million worth of goods and services in year one. In year two, the GDP increased to $17 million. On the surface, it looks like the total output grew by 20% from one year to another. However, if the prices rose by 10% from the first year to the next, then the $17 million GDP figures would inflate when you compare them to the first year. 

The reality is that the economy grew by 10% from the first year to the next due to inflation. The GDP measure which takes into consideration inflation is called the Real GDP. So, in the example, the nominal GDP for the second year would be $17 million while the real GDP would be $16 million. 

GDP Deflator Formula

If you want to calculate the GDP price deflator, you will need to follow a formula. It would be best if you had the following GDP deflator formula to calculate the GDP price deflator. 

Here is the GDP deflator equation:

GDP Price Deflator = \[(\frac{N\: GDP}{R\: GDP})\times100\] 

N GDP is nominal GDP 

R GDP is real GDP

You will be able to calculate the GDP easily with the help of this formula any time you are trying to find the real GDP of an economy. This formula will help you see how the price changes, inflation and deflation change the economy's GDP over the years. 

How to Calculate GDP Deflator?

When you use the GDP deflator formula, you will calculate the real GDP of an economy. Here's an example of how to calculate GDP deflator. 

Example: 

Suppose the economy has a nominal GDP of $12 billion and a real GDP of $10 billion. The economy's GDP Price Deflator would be calculated as: 

GDP Price Deflator = GDP Price Deflator = ( $12 billion ÷ $10 million) × 100

GDP Price Deflator = 120

The result means that the aggregate level of prices increased by 20% from the base year to the current year. This is because the economy's real GDP is calculated by multiplying its current output from its price from the base year. It is how you can calculate the GDP of any economy. 

Benefits of GDP Price Deflator

One of the main benefits of GDP price deflator is that it helps you identify how much prices have inflated over some time. This is one of the main reasons you need to regulate the GDP of the economy closely. 

As we saw in the above example, when you compare the GDP from two different years, it can be deceptive if there has been a change in the price level. You need to know the real GDP of the economy, and the GDP deflator helps you calculate it. 

When you don't account for the changes in the price, the economy experiencing price inflation will look like it's growing in terms of dollars. However, the same economy, in reality, would be showing no growth, and with the rise in prices, the total output would be looking higher than the prices which are accurate.

Conclusion

It’s important that you should know about the concept of Gross Domestic Product (GDP) price deflator and the way you can calculate it. It's a concept you can use for a long time to calculate the real GDP of the economy. If you want to know the development and growth of the economy over a year or two, you should use the GDP Deflator to calculate it.