GDP Deflator Formula (Table of Contents)
What is GDP Deflator Formula?
The term “GDP deflator” refers to the index that helps in determining price inflation or deflation in the economy. In other words, the GDP deflator is a measure of the general price level of all the goods and services being produced in an economy. The formula for GDP deflator is very simple and it can be derived by dividing the nominal GDP by the real GDP and then the result is multiplied by 100. Nominal GDP captures the valuation of all goods and services at current prices, while real GDP is the valuation of the same at constant prices without the effect of inflation. Mathematically, the formula for GDP deflator is represented as,
Examples of GDP Deflator Formula (With Excel Template)
Let’s take an example to understand the calculation of GDP Deflator in a better manner.
GDP Deflator Formula – Example #1
Let us take a simple example of an economy where the nominal GDP (valued at current prices) is $5.65 million and real GDP (valued at constant prices of the base year 2014) is $4.50 million during the year 2019. Calculate the GDP deflator for the economy.
Solution:
GDP Deflator is calculated using the formula given below
GDP Deflator = (Nominal GDP / Real GDP) * 100
- GDP Deflator = $5.65 million / $4.50 million * 100
- GDP Deflator = 125.56
Therefore, the GDP deflator for the economy stood at 125.56 during the year 2019.
GDP Deflator Formula – Example #2
Let us take the example of some random items, namely product X and product Y. The following information about the production quantity and prices of the products for the last three years is available where the year 2016 is to be treated as the base year. Based on the given information, calculate the GDP deflator for the year 2016, 2017 and 2018.
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Solution:
Nominal GDP is calculated using the formula given below
Nominal GDP = (Quantity of Product X * Price of Product X) + (Quantity of Product Y * Price of Product Y)
For 2016
- Nominal GDP = (100 * $2.00) + (200 * $1.00)
- Nominal GDP = $400
For 2017
- Nominal GDP = (180 * $3.00) + (250 * $1.50)
- Nominal GDP = $915
For 2018
- Nominal GDP = (250 * $3.50) + (300 * $2.50)
- Nominal GDP = $1,625
For 2016
- Real GDP = (100 * $2.00) + (200 * $1.00)
- Real GDP = $400
For 2017
- Real GDP = (180 * $2.00) + (250 * $1.00)
- Real GDP = $610
For 2018
- Real GDP = (250 * $2.00) + (300 * $1.00)
- Real GDP = $800
GDP Deflator is calculated using the formula given below
GDP Deflator = (Nominal GDP / Real GDP) * 100
For 2016
- GDP Deflator = ($400 / $400) * 100
- GDP Deflator = 100
For 2017
- GDP Deflator = ($915 / $610) * 100
- GDP Deflator = 150
For 2018
- GDP Deflator = ($1,625 / $800) * 100
- GDP Deflator = 203.13
Therefore, the GDP deflator for the year 2016, 2017 and 2018 stood at 100, 150 and 203.13 respectively. This indicates that compared to 2016 the price level has increased by 50% in 2017 and 103.13% in 2018.
Explanation
The formula for GDP deflator can be derived by using the following steps:
Step 1: Firstly, determine the nominal GDP of the subject economy. It is the product of all the goods and services produced in the economy and their respective current prices. The current price can either increase or decrease over a period of time-based on inflation or deflation in the economy respectively.
Step 2: Next, determine the real GDP of the economy and it is the product of all the goods and services produced in the economy and their respective constant prices. The constant price is the price in the base year which does not change due to inflation or deflation.
Step 3: Finally, the formula for GDP deflator can be calculated by dividing the nominal GDP (step 1) by the real GDP (step 2) and then the result is multiplied by 100 as shown below.
GDP Deflator = (Nominal GDP / Real GDP) * 100
Relevance and Uses of GDP Deflator Formula
The concept of GDP deflator is a very important economic metric as it helps in capturing the changes in the price level in an economy by measuring all the factors of the GDP. Although GDP deflator is similar to other price indices, like Consumer Price Index (CPI) and Wholesale Price Index (WPI), the major difference between it and the other price indices is that it is not based on a fixed basket of goods and services. The GDP deflator is determined on the basis of a dynamic basket that alters its composition based on the requirement of each case.
Further, the difference between GDP deflator and a price index is usually quite small. However, governments prefer utilizing price indexes over GDP deflator for fiscal and monetary planning because even the smallest of differences in inflation measure can alter the budget big time as they run into billions and trillions of dollars.
GDP Deflator Formula Calculator
You can use the following GDP Deflator Calculator
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