What is the GDP Deflator

Nominal and real GDP

This article covers the difference between the real and the nominal gross domestic product. After adefinition we show you on oneExample, like the prosperity indicatorscalculated become. We'll also go into how you can make price changes using the GDP deflators can calculate.

Our Video explains everything you want to know about gross domestic product need to know - uncomplicated and in the shortest possible time!

Gross domestic product simply explained

The gross domestic product or short GDP is one of the central measures of a country's economic performance within economics. It indicates the value of all goods in an economy that were produced for the end consumer in a given period. Since the prosperity of the individual residents also benefits from a well-functioning economy, this value is also called Prosperity indicator used.

If GDP is high, economists assume that prosperity is also high, and if it is low, they assume that prosperity is rather low. However, we will see later why this interpretation can be problematic.

Definition of nominal and real GDP

The nominal GDP sums up all current market prices of the goods that were produced in an economy for the end consumer during a certain period.

The price-adjusted real GDP forms this value independently of price changes by using the prices of a base year.

Difference between nominal and real GDP

Let us now come to the distinction between real gross domestic product and nominal gross domestic product. The only big difference between the two measures is that in nominal GDP Price changes such as a inflation not be taken into account, but with real ones.

In other words, the nominal GDP uses the current prices of the products / services in the calculation. However, if the price rises due to inflation, the cause of the increase is not taken into account in the calculation of GDP and could be mistakenly interpreted as prosperity growth.

In the case of real GDP, however, causes such as inflation are taken into account. One calculates with constant values ​​of a set base year and can thus avoid a bias.

To better understand what this difference means, let's now look at how nominal and real GDP are calculated.

Calculate nominal GDP

To that calculate nominal GDP To be able to do this, the amount of all goods produced is simply multiplied by the current prices.

Let's imagine the calculation using an example. In our economy only one good is produced, namely doner kebab. Let's say exactly one kebab is produced for five euros in the first year, so our nominal gross domestic product is five euros. Let us now imagine that exactly one kebab is produced again in the second year. The prices have now risen, so that the kebab now costs seven euros instead of five euros. Our new nominal GDP is seven euros, which is higher than last year.

As already said, the gross domestic product can also be called Prosperity indicator be used. So, as an economist, we would say that our economy has grown prosperity because nominal GDP has increased. But that doesn't really make sense, since only one kebab has been made. The higher value was only caused by the price increase.

Calculate real GDP

In order to avoid this distortion, the calculation of the real gross domestic product does not use current prices, but rather constant prices.

So based on prices, real GDP becomes one Base year, with the help of Laspeyres Index or the Paasche Index. Let's look at the whole thing again using our example. We call our first year in which we produce doner kebab year 1. This is now our base year. As before, we produce a kebab for five euros in the first year and a kebab for seven euros in the second year. In order to calculate the real GDP in the second year, however, we are not using the seven euros as the price this time, but the five euros from our base year, because we want to calculate with constant prices.

The interpretation of gross domestic product as an indicator of prosperity now also makes more sense. Since real GDP has stayed the same, we can conclude that wealth has not changed either. This also makes sense in terms of content, because we still only produced one kebab.

GDP deflator - calculation of price changes

So we have now managed to avoid the distortions caused by price changes. But how do you actually calculate these price changes? One possibility is that GDP deflatorwhich onePrice index is. That is, it gives you the relationship between nominal and real Gross domestic product and shows you how the prices have changed between the base year and the current year.

If the GDP deflator is <100, there is a decrease in the price level, i.e. deflation. If the GDP deflator is exactly 100, the prices have not changed. Let's calculate the whole thing again using our example. Our nominal gross domestic product was seven euros and our real one was five euros. If we put that into the formula, the result is a value of 140. Since 140 is greater than 100, in our example it results in an inflation of 40 percent.