GDP Deflator: Definition, Formula & Example

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  • 0:00 Gross Domestic Product Defined
  • 1:28 Variables Needed to…
  • 2:09 Calculating the GDP Deflator
  • 2:24 Example of GDP…
  • 3:00 Lesson Summary
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Lesson Transcript
Instructor: Adam Gifford

Adam holds an MBA and a MS in Human Resources

In this lesson, we will be discussing the GDP deflator. It's an effective method that is used to measure price changes over time within an economy. We'll go into more depth about the concept and illustrate an example of how it is calculated.

Gross Domestic Product Defined

The Gross Domestic Product (GDP) of a country is the value of all the goods produced in a country over the course of a year. This number is used to roughly calculate the size of a particular economy. The GDP can be used to show the increase or decrease in the size of an economy over a time period. The challenge with this is that the prices for those goods and services can change with time. A general increase in prices is known as inflation and a general decrease in prices is known as deflation. These changes in prices make it difficult to compare current prices with historical prices.

Let's look at how this effect can create confusion. We will look at the GDP of the fictitious country of Pantonia:

Pantonia's GDP last year: $100,000

Pantonia's GDP this year: $107,000

Pantonia's inflation: 7%

When you look at the GDP numbers it looks like the economy of Pantonia has increased by $7,000. When you take the inflation into consideration it shows that prices have increased by 7%. This means that things got more expensive, but the same amount of production occurred between the two years.

This is where the GDP deflator comes into play. The GDP deflator is a tool used to measure the level of price changes over time so that current prices can be accurately compared to historical prices. In other words, it eliminates the effects of price changes over time.

Variables Needed to Calculate GDP Deflator

There are two variables that are needed in order to calculate the GDP deflator.

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