The GDP deflator is utilized as a measure of shifts in the prices of goods and services that are produced in a given country. It is understood that the GDP deflator can help provide a more accurate picture of the current status of the gross domestic product within the country. Because the GDP deflator is understood to be an example of an implicit price deflator for GDP, economists consider calculating this economic indicator as an essential component in ascertaining the current strength or weakness of the country’s economy.
The formula for calculating the GDP deflator is relatively simple. Essentially, the calculation requires current information regarding the chain volume measure or real GDP, and the current price or nominal GDP. This figure is calculated by taking the nominal GDP, dividing it by a known deflator, and multiplying the result by one hundred. This final figure will represent the real current status of the gross domestic product, as it allows for the change or deflation of the nominal GDP into real world terms.
One of the easiest ways to think of the GDP deflator is to think of it as current dollars and conditions compared to the same set of factors in a previous time period. For example, an idea of the GDP deflator associated with the most recent calendar year can be ascertained by looking at the state of the GDP in a previous calendar year. This can be helpful in determining if an inflation of the GDP is taking place from one period to another.
It is possible to use this approach both with the broad GDP for an entire country, or to understand the economic stability of some sub-category within the economy of the country. Businesses will often use this approach to gauge conditions within their own industry. Using the current year price and the number of units produced, as compared to the price and production of a previous year can help to indicate whether there is actually growth or shrinkage taking place.
The formula for the GDP deflator may indicate that the relationship between units and unit price is shifting in some manner, such as more generated revenue but less units produced. This would indicate the presence of upward price changes or price inflation. At the same time, less revenue generated from more produced units indicates downward changes in prices that may eventually drive some manufacturers out of the industry.