The GDP deflator is a measure of the level of price inflation or deflation and is used to adjust nominal GDP.
The GDP deflator is a number that represents the current prices of various goods and services versus their past prices of a given year. It used to measure the level of price changes over time relative to a base year. This allows economists to measure and track inflation or deflation. If current prices are used to measure GDP, true economic output can be over- or understated. The GDP deflator compensates for changing price levels over time (inflation or deflation). This measure is an implicit index of the price level that allows economists to measure real changes in economic output. Economists also use it to convert nominal GDP in any given year into real GDP.
Economists analyze changes in real GDP to determine the growth of output in an economy. Real GDP measures the total value produced using constant prices, isolating the effect of price changes. As a result, real GDP is a better gauge of changes in the output level of an economy.
Change in GDP
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. If the nominal GDP and the GDP deflator are both known quantities but real GDP is not, the following formula can be used to solve for real GDP: