What is GDP Deflator? A Simple Guide to Understand All about GDP Deflator

Gross Domestic Product

If you are preparing for the UPSC exam then the term GDP deflator is not new to you. You must be wondering what is a GDP deflator?

The GDP deflator is a measure of inflation and is also called implicit price deflator. It helps to record and measure all the price level changes of an economy in the output of goods and services of one year. Gross domestic product deflator shows the amount of change in GDP due to inflation and not increase in output.

It is expressed under a ratio form and the GDP deflator formula is 100 × NOMINAL GDP ÷ REAL GDP

Terms related to GDP deflator:

  • Nominal Gross Domestic Product
  • Real Gross Domestic Product

What does GDP Deflator Do?

Next, you may wonder what the GDP deflator does.  As mentioned it measures the change in prices for all goods and services in an economy.

This further helps economists of the country to understand the level of inflation in the economy, compare levels of real economic activities and ways to curb inflation. It takes into account all the goods and services produced and thus is preferred over other measures of inflation.

Importance of GDP Deflator

The GDP deflator is among the measures of inflation. When compared to other measures like consumer product index (CPI) and wholesale price index (WPI) it is of a much broader sense. It calculates inflation on the whole economy and not just on a basket of select goods like CPI or WPI.

Any change in consumption pattern or structural reforms are directly considered into the GDP deflator. Though CPI and WPI are available on a monthly basis they do not give a clear picture of inflation in the economy.

Real GDP vs Nominal GDP

Now, it is important to understand the components of GDP deflator for your UPSC exam.

Real gross domestic product is an inflation-adjusted measure that gives us the value of the gross domestic product of an economy in a particular year. It is estimated as an index of the total quantity of output and in layman’s terms is the regular GDP we talk about. It is also called constant price GDP.

Nominal gross domestic product is the monetary value of all goods and services produced in an economy in a particular year at current prices. This causes it to keep changing every year as the prices of goods may increase due to inflation.

In case if inflation exists and is high, then the value of Nominal GDP will be higher as it is based on current year prices than the Real GDP

If Inflation does not exist or is low then the Real GDP value will be greater than nominal GDP value.

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Real GDP vs Nominal GDP

Real GDP Nominal GDP
It is adjusted for inflation It does not adjust for inflation
It is calculated using prices of base year It is calculated using prices of the current year
Real GDP= Nominal GDP ÷ GDP Deflator Nominal GDP=C+I+G+(X-M)

Real GDP Formula and Nominal GDP Formula

The  formula for Real GDP is:

Nominal GDP ÷ GDP Deflator

The formula for Nominal GDP is:

C+I+G+(X-M)

Here,

C= Private consumption

I= Gross investment

G= Government Investment

X= Exports

M= Imports

For example:

Let the private consumption be ₹500 crores, gross investment be  ₹250 crores, government investment be  ₹460 crores, exports  ₹700 crores, imports  ₹650 crores and GDP deflator is  ₹40 crores.

Then Nominal Gross Domestic Product = 500+250+460+700+650=  ₹2560 crores

Real Gross Domestic Product= 2560 ÷ 4=640 crores

Common Mistake

It is always believed that if the gross domestic product is higher than the previous year it implies that the output of that year has increased. That is not the case. It is important to understand whether there is an increase in Real gross domestic product or Nominal gross domestic product.

If an increase in Nominal gross domestic product exists then it may be only because of price change whereas the change in the Real gross domestic product implies an increase in output levels.

Conclusion

GDP deflator for your UPSC exam may look like a very complex topic but in reality is very easy to understand. This blog helps you break down the topic and go through the various aspects related to it, like Real gross domestic product, Nominal gross domestic product deflator formula and much more. This should help you look into the details of the topic and help you understand it better.

For many such needs for your UPSC exam, you can visit this website. It will help you prepare better, give you tests and provide you with mentors that will guide you and prepare you for a better score.

Also Read : Most Brilliant IAS Questions: Here are Some of the Trickiest UPSC Interview Questions

Summary
What is GDP Deflator? A Simple Guide to Understand All about GDP Deflator
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What is GDP Deflator? A Simple Guide to Understand All about GDP Deflator
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Are you preparing for UPSC? If yes, then this blog will help you to understand GDP deflator and terms related to it for your UPSC exam and increase your score.
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UPSC Pathshala
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