What is GDP Deflator? A Simple Guide to Understand All about GDP Deflator
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.
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= Private consumption
I= Gross investment
G= Government Investment
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
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.
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.
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