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How to calculate GDP Deflator?


 How to calculate GDP using GDP Deflator?


To know this process at first we need to know about two types of GDP; those are

1. Nominal GDP:    Nominal GDP shows the production of goods and services at the current year. In nominal GDP price or quantity may be increased.

This can be best explained by an example below:

Year
Price of good A
Quantity of good A
Price of good B
Quantity of good B
2001
1
100
2
50
2002
2
150
3
100
2003
3
200
4
150



Here, Nominal GDP of 2001 = (1 X 100) + (2 X 50) = 200

                                        2002 = (2 X 150) + (3 X 100) = 600

                                          2003 = (3 X 200) + (4 X 150) = 1200

Limitations:              It is easy to see that GDP computed this way is not a good picture of economic well being. That is, this measure does not accurately reflect how well the economy can satisfy the demands of household, firms, government. If all prices doubled without any change in quantities, Nominal GDP would double. Yet it would be misleading to say that the economy’s ability to satisfy the demand has doubled because the quantity of every good produced remains the same.

2. Real GDP:    Real GDP shows the production of goods and services valued at constant price especially at base year price. This is a better measurement than Nominal GDP, because it shows what would have happened to expenditure on output if quantities had changed but prices had not.

This can be explained by considering the above table. Form the table:

Real GDP, where base year is 2001 = (1 x100) + (2 X 50) = 200

                                                               = (1 x150) + (2 X 100) = 350

                                                                = (1 x200) + (2 X 150) = 500





                                    The GDP Deflator


From the nominal GDP and real GDP we can compute the GDP deflator.

The GDP deflator, also called the implicit price deflator GDP, is the ration of nominal GDP and real GDP. That is ,



                             GDP Deflator = Nominal GDP/ Real GDP

From the equation we can state that:

Nominal GDP measures the current dollar value of the output of the economy.

Real GDP measures output value at constant prices.

The GDP deflator measures the price of output relative to its price in the base year.



Therefore, to calculate GDP using GDP deflator we use the following formula:



   Nominal GDP = Real GDP X GDP Deflator

   Real GDP =  Nominal GDP / GDP Deflator
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