Encyclonomic WEB*pedia: GDP PRICE DEFLATOR

GDP PRICE DEFLATOR:
A price index calculated as the ratio nominal gross domestic product to real gross domestic product. Also commonly referred to as the implicit price deflator, the GDP price deflator is used as an indicator of the economy's average price level. This price index is tabulated and reported every three months along with the gross domestic product, national income, and related measures that make up the National Income and Product Accounts maintained by the Bureau of Economic Analysis (BEA). The GDP part of GDP price deflator stands for gross domestic product.
The GDP price deflator is actually something of a bi-product in the estimation of GDP in both nominal and real terms. Nominal GDP measures current production at current prices. Real GDP, in contrast, measures current production at constant prices (those existing in a base period, such as 2000). Because the ONLY difference between nominal and real GDP is the prices used to estimate the market value of production, a comparison between nominal and real GDP implicitly reveals the change in prices from the base period to the current period.
The Historical Trend
GDP Price Deflator
The trend in the GDP price deflator is pictorially presented in this chart. Over the years, the GDP price deflator has exhibited a relatively steady upward trend, rising from a miniscule 15 in 1947 to almost 110 in 2003. The base period for the GDP price deflator is the years 2000, which is equal to 100. One section of this trend worth noting is:
From 1974 to 1981, the GDP price deflator experienced a steep rise. This was a period of high inflation rates associated, at least in part, with tremendous increases in petroleum prices. While modest inflation tends to be a natural part of the U.S. economy, the high inflation experienced during the 1970s exceedingly rare.
Common Uses
The GDP price deflator has two common uses: (1) as an indicator of the price level and economic activity and (2) as a method of deflating nominal economic indicators to real terms.
Price Level Indicator: The most common use of the GDP price deflator is as an indicator of the economy's price level, and perhaps even more importantly, as a means of estimating the rate of inflation. The CPI-based inflation rate may be more widely reported by the media, but the GDP price deflator is usually the measure of choice when economists need precision in the analysis of inflation and related macroeconomic phenomena. While the GDP price deflator is not reportedly as frequently as the CPI (quarterly versus monthly), it does provide a more comprehensive measure of the price level and thus inflation. This is why the aggregate market analysis uses the GDP price deflator to measure the price level.

Deflating Nominal to Real: Economists, business leaders, and government policy makers often find it useful to convert current, or nominal economic indicators to real terms, that is to eliminate any inflationary increases of the nominal values. In fact, the "deflator" part of the GDP price deflator comes about because it is used to deflate nominal GDP to real GDP.
Deriving the Deflator
The GDP price deflator is made possible because the BEA measures GDP in both nominal dollars and real dollars. Nominal GDP measures current production at current prices and real GDP measures current production at constant prices, prices existing during a base period. Nominal 2002 GDP, for example, is the value of 2002 production at current 2002 prices. In contrast, real 2002 GDP is the value of 2002 production at constant 2000 prices. Comparing nominal GDP and real GDP indicates how current prices, that is, the economy's price level, have changed since the base period.
Estimating nominal and real GDP are quite involved, to say the least. However, once real and nominal GDP have been meticulously estimated, the derivation of the GDP price deflator is relatively straightforward. This equation indicates how simple it is, divide nominal GDP by real GDP, then multiply by 100:
GDP price deflator = nominal GDP
real GDP x 100
For example, nominal GDP in 2002 was $10,480.8 billion and real GDP in 2002 (using 2000 prices) was $10,083.0 billion. The ratio of nominal to real (after multiplying by 100) is 103.95.
GDP price deflator = $10,480.8
$10,083.0 x 100 = 103.95
The interpretation of this 103.95 value for GDP price deflator in 2002 is that the average price level in the economy increased by 3.95 percent from 2000 (the base period for estimating real GDP) to 2002. Calculating the percentage change the GDP price deflator from one year to the next, then provides an excellent measure of the inflation rate. For example, the GDP price deflator is 102.38 for 2001 and 103.95 for 2002, a change of 1.54 percent.
A Family of Measures
The GDP price deflator is actually one of several price indexes associated with the National Income and Product Accounts. These indexes fall into one of two categories, (1) implicit deflators derived from corresponding nominal and real values and (2) chain-type price indexes used to estimate real values.
Implicit Deflators: In the same way that the GDP price deflator is derived as the ratio of nominal GDP and real GDP, a national income price deflator (NI price deflator) can be derived as the ratio of nominal NI and real NI. Similar price deflators can be derived for virtually every other measure in the National Income and Product Accounts, including net domestic product, personal income, gross national income, personal consumer expenditures, gross private domestic investment, to name just a few. However, other than a few of the comprehensive measures, like GDP and GNP, price deflators for other measures are not regularly reported by the BEA. But they are very easy to calculate.

Chain-Type Price Indexes: The second set of price indexes, which are regularly reported by the BEA, are chain-type price indexes. These indexes are used to derive real measures of GDP, national income, consumption expenditures, etc. For the most part, chain-type price indexes and implicit price deflators have nearly equal values for a given measure. For example, the 2002 chain-type price index for GDP was 103.95, compared to a GDP price deflator value of 103.95.
Pros and Cons
There are three important points to note about the GDP price deflator, two pro and one con. These points are especially important when comparing the GDP price deflator to the CPI.
First, the GDP price deflator is based on ALL production in the aggregate economy. This is a definite pro. It includes not just urban consumption, as does the CPI, but also investment expenditures for capital goods, purchases by the government sector, and even exports to the foreign sector. It has it all. So for anyone truly interested in a price index for the aggregate economy, this is it.

Second, the GDP price deflator measures the prices of "current production", the prices of goods actually produced during the current year. This also a definite pro. The CPI, in contrast is based on a market basket of goods identified 5 or 10 years earlier. Again, from a macroeconomic perspective, this is a much better way to go.

Third, the GDP price deflator is reported quarterly, every three months, along with other measures in the National Income and Product Accounts. The GDP price deflator for the first three months of the year (January, February, and March) is not available until late April or May. And then, it is only a 3-month average rather than a month-by-month, blow-by-blow price index. From a timeliness perspective, the GDP price deflator comes up short on providing decision makers with the information needed.
Check Out These Related Terms...
     | Consumer Price Index | Producer Price Index | Wholesale Price Index | Consumer Price Index for All Urban Consumers | Consumer Price Index for Urban Wage Earners and Clerical Workers | CPI and GDP price deflator |
Or For A Little Background...
     | inflation | price level | price index | gross domestic product | real gross domestic product | nominal gross domestic product | cost of living | business cycles | business cycle indicators | macroeconomics | macroeconomic goals | macroeconomic problems | production possibilities |
And For Further Study...
     | deflation | disinflation | inflation problems | inflation causes | demand-pull inflation | cost-push inflation | unemployment rate | Bureau of Labor Statistics | Bureau of Economic Analysis | National Income and Product Accounts | National Bureau of Economic Research | aggregate market | aggregate market analysis |
Recommended Citation:
     GDP PRICE DEFLATOR, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2025. [Accessed: January 10, 2025].