What Is the GDP Price Deflator and Its Formula? (2024)

What Is the GDP Price Deflator?

The gross domestic product (GDP) price deflator is a formula that measures the amount to which the real value of an economy's total output is reduced by inflation. The GDP deflator formula takes into account the value of all final goods including exports. It does not factor in the prices of imports.

The GDP deflator formula is used by the Bureau of Economic Analysis (BEA). It helps economists track more accurately how the economy is faring over time while taking inflation into account.

Key Takeaways

  • GDP measures the market value of all goods and services produced in an economy.
  • The GDP price deflator measures the changes in prices of all the goods and services produced in an economy.
  • Using the GDP price deflator helps economists compare the levels of real economic activity from one year to the next.
  • The GDP price deflator is a more comprehensive inflation measure than the Consumer Price Index (CPI), which measures the price changes in a fixed basket of goods.

Formula and Calculation of the GDP Price Deflator

The following formula calculates the GDP price deflator:

GDPPriceDeflator = (NominalGDP ÷ RealGDP) × 100

To calculate the GDP price deflator, divide the nominal GDP by the real GDP and multiply the result by 100. Nominal GDP is the total value of goods and services produced during a specific period less the value of products made during production. Real GDP refers to the value of goods and services produced in a year and adjusted for inflation.

Understanding the GDP Price Deflator

GDP represents the total output of goods and services. But it doesn't factor in the impact of inflation or rising prices. The GDP price deflator addresses this by showing the effect of price changes on GDP. The price deflator formula establishes a base year and compares current prices to the base year prices.

The GDP price deflator shows how much of a change in GDP relies on changes in the price level. It estimates the extent of price level changes, or inflation, within the economy by tracking the prices paid by businesses, the government, and consumers.

How the Price Deflator Is Used

Some companies use the GDP price deflator to adjust their contract payments.

The GDP price deflator closely resembles another economic metric—the GDP Price Index, which also measures the rise in prices of goods and services, including exports.

However, the two metrics are calculated differently.

Data for the GDP price deflator is calculated and reported by the BEA every quarter based on data reported every month. As of the first quarter of 2024, the GDP price deflator increased by 3.1%, compared to an increase of 1.7% during the fourth quarter of 2023.

Benefits of the GDP Price Deflator

The GDP price deflator helps identify how much prices have inflated over a specific time. This is important because comparing GDP to a previous year can be deceptive if there's a change in the price levels between both periods.

Without some way to account for the change in prices, an economy that experiences price inflation would appear to be growing in productivity when it is really growing only in dollar terms.

The GDP price deflator helps to measure the changes in prices when comparing nominal to real GDP over several periods.

GDP Price Deflator vs. the Consumer Price Index (CPI)

Other indexes measure inflation. Many of these alternatives are based on a fixed basket of goods. These include the consumer price index (CPI), which measures the level of retail prices of goods and services over time.

The CPI is an important inflation measure because it reflects real changes to a consumer's cost of living. However, all calculations based on the CPI are direct, which means the index is computed using prices of goods and services already included in the index.

The fixed basket used in CPI calculations is static and sometimes misses changes in prices of goods outside of the basket of goods. For instance, changes in consumption patterns or the introduction of new goods and services are automatically reflected in the deflator, but not in the CPI.

This means that the GDP price deflator captures any changes in an economy's consumption or investment patterns. That said, the trends of the GDP price deflator are usually similar to the trends illustrated in the CPI.

Example of the GDP Price Deflator

GDP, often referred to as nominal GDP, shows the total output of the country in whole dollar terms. That can be deceptive.

For example, say the U.S. produced $10 million worth of goods and services in year one. In year two, the output or GDP increased to $12 million. On the surface, it would appear that total output grew by 20% year-on-year. However, if prices rose by 10% from year one to year two, the $12 million GDP figure would be inflated when compared to year one.

In reality, the economy only grew by 10% from year one to year two, when considering the impact of inflation. The GDP measure that considers inflation is called the real GDP. So, in the example above, the nominal GDP for year two would be $12 million, while the country's real GDP would be $11 million.

What Is Gross Domestic Product (GDP)?

Gross domestic product is the total value of all the finished goods and services produced within a country’s borders within a specific time. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.

Though GDP is usually calculated annually, it is sometimes calculated every quarter as well. The U.S. government releases anannualizedGDP estimate for each fiscal quarter and for the calendar year. The individual data sets included in the report are given in real terms, so the data are adjusted for price changes and are, therefore, net ofinflation.

What Is Deflation?

Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power increases.

What Is the Consumer Price Index (CPI)?

The Consumer Price Index is a measure of theweighted averageof the prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predeterminedbasket of goodsand averaging them.

Changes in the CPI are used to assess price changes associated with thecost of living.

The CPI is one of the most frequently used measures ofinflation and deflation. It may be compared with theproducer price index (PPI), which instead of considering prices paid by consumers looks at what businesses pay for inputs.

The Bottom Line

The CPI is important because it tracks the changes in the prices of a fixed basket of goods that most American consumers use regularly. But it omits changes in prices of goods outside of that basket.

GDP is the total of all goods and services produced in the economy, and the number is tracked consistently as a way to determine the health of an economy. In this case, inflation is relatively irrelevant and even confuses the issue.

The GDP price deflator separates the inflation factor from GDP so that each element can be analyzed separately.

What Is the GDP Price Deflator and Its Formula? (2024)

FAQs

What Is the GDP Price Deflator and Its Formula? ›

Formula and Calculation of the GDP Price Deflator

What is the GDP deflator calculator? ›

GDP Deflator Formula Calculator. This GDP deflator formula calculator measures the price level calculated as the ratio of nominal GDP to real GDP times 100. In other words, it helps you to determine the price level of all domestically produced final goods and services, also taking into account the exports of a country.

What is the formula for nominal GDP and GDP deflator? ›

Nominal GDP = Real GDP x GDP Deflator

Real GDP: An economic measure that accounts only for the change in quantity output. GDP Deflator: A measurement of the change in price over a duration of time (inflation or deflation). It is calculated as the ratio of Nominal GDP to Real GDP.

What is the formula for deflation? ›

The rate of deflation can be calculated like this: Look at the price index of the current year (CPIc) and the price index of the previous year (CPIp). Subtract the current year (CPIc) from the previous year (CPIp). Divide the result by the CPI from the previous period.

What is the formula for GDP example? ›

GDP = consumption + investment + government spending + net exports. In this case, $200 million + 55 million + $120 million + $80 million + $45 million = $500 million. Then imports of $50 million is subtracted to get GDP = $450 million.

How do you calculate the GDP deflator? ›

The nominal GDP of a given year is computed using that year's prices, while the real GDP of that year is computed using the base year's prices. The formula implies that dividing the nominal GDP by the real GDP and multiplying it by 100 will give the GDP Deflator, hence "deflating" the nominal GDP into a real measure.

What is GDP price deflator? ›

The gross domestic product implicit price deflator, or GDP deflator, measures changes in the prices of goods and services produced in the United States, including those exported to other countries.

How do you find the equation for the GDP deflator? ›

To calculate the GDP price deflator, divide the nominal GDP by the real GDP and multiply the result by 100.

How to calculate implicit price deflator for GDP? ›

Implicit price deflator = nominal GDP / real GDP

Following the convention of multiplying price indexes by 100, the published number for the implicit price deflator was 119.8.

What is the formula for GNP deflator? ›

GNP Deflator = Nominal GNP / Real GNP × 100

The percentage is usually expressed with three decimal places.

Who benefits from inflation? ›

Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.

Why is deflation so bad? ›

Typically, deflation is a sign of a weakening economy. Economists fear deflation because falling prices lead to lower consumer spending, which is a major component of economic growth. Companies respond to falling prices by slowing down their production, which leads to layoffs and salary reductions.

How to reverse inflation? ›

When confronting inflation, a government's central bank may take actions that reduce the nation's money supply. This contractionary monetary policy is achieved through higher interest rates and changes in open market operations.

What is the formula for GDP deflator inflation? ›

For example, if the GDP deflator in the current year is 110 and the GDP deflator in the previous year is 100, the inflation rate would be ((110 – 100) / 100) x 100 = 10%. This means that prices have increased by 10% from the previous year.

What is the definition of a deflator? ›

A deflator is a figure expressing the change in prices over a period of time for a product or a basket of products, which is used to 'deflate' (price adjust) a measure of value changes for the same period (for example the sales of this product or basket), thus removing the price increases or decreases and leaving only ...

What is the difference between CPI and deflator? ›

GDP deflator is a measure of all products and services of the country (including non-consumer goods and services), while the CPI uses only consumer goods. GDP deflator includes only domestic goods, while CPI includes anything bought by consumers, which includes non-domestic products (imported or foreign-made).

How to calculate nominal GDP calculator? ›

The nominal GDP formula: GDP = C + I + G + (X-M), where C is consumption or money spent by people, I is investments, G is government spending, and (X_M) is export-import net proceeds.

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