GDP Deflator

What is GDP? 

Before delving deep into the concepts of nominal and real GDP, students must first understand GDP and all of its associated features. GDP, or Gross Domestic Product, is a metric that calculates the economic or market value of all goods and services produced in a country over a specific period. GDP is typically computed on an annual basis, but it can also be computed quarterly. GDP is a broad metric that depicts a country’s economic health over time. It can be used to calculate a country’s growth rate and economic size. As a result, it can be used by businesses in a variety of decision-making processes.

What is the definition of nominal GDP?

The nominal Gross Domestic Product (GDP) is calculated using current market prices. As a result, nominal means that it includes all changes in market prices caused by inflation and depletion for the current year. As a result, it reflects the current market value of goods and commodities produced at a given time. 

What is the definition of Real GDP?

Real GDP, as opposed to nominal GDP in India, is an inflation-adjusted calculation of GDP. It is a conservative estimate of the total value of all goods and commodities produced in a given year that accounts for inflation.

GDP Calculation Methods

The GDP, or Gross Domestic Product, can be calculated in three ways, as detailed below:

Expenditure Method

This is the most common method for calculating a country’s GDP, which is based on expenditures incurred by all citizens within the country’s borders on various goods and services rather than income. The nominal GDP is calculated using this method. The following is the formula:

GDP equals C + G + I + NX.

Here,

C stands for Total Consumption Expenditure.

Total Government Expenditures (G)

I  – stands for Total Investments.

NX stands for Net Exports.

C: It refers to the total amount spent by all consumers on goods and services such as food, transportation, clothing, and fuel.

I: Investment Expenditure refers to money spent by people on business activities such as purchasing plants and machinery, purchasing land, and so on.

G: The government’s expenditure on various developmental activities.

NX: It stands for net exports, which are calculated by subtracting total imports from total exports.

Method of Earning

This method includes all income generated by factors of production that are inputs in the process of producing final goods or services throughout the economy. Land, labour, capital, and management/entrepreneurship are the factors of production, and the income from these is divided into rent, wages, interest, and profits. GDP will be the total of all of these incomes. The GDP formula, also known as the GDP equation, is as follows:

Wages + Rent + Interest + Profits = Net National Income

This is the Net National Income, and we must make some adjustments to get to the Gross National Income. The GDP calculation formula for this is as follows:

Wages + Rent + Interest + Profits + Depreciation + Net Foreign Factor Income = GDP (Factor Cost).

You will receive final income at factor cost before tax as a result of this. To calculate GDP at market value, use the following formula:

GDP (Factor Cost) + (Indirect Taxes – Subsidies) = GDP (Market Cost).

Method of Output (Production)

Under this method, the GDP can be calculated using the following formula:

GDP Formula = Real GDP (GDP in constant prices) – Taxes + Subsidies

This is also known as a value-added method because it considers the value-added at various stages of the final product’s production process. To calculate GDP at market price, the gross value added of all three sectors, namely primary, secondary, and tertiary, is calculated. The following formula can be used to calculate the gross value added:

Gross value added (GVA) = output value minus intermediate consumption

The following formula can be used to calculate national income at factor cost:

NNP (Factor Cost) = GDPMP – Depreciation + Net foreign factor income – Indirect taxes + subsidies

GDP Deflator

•    The GDP deflator, commonly known as the Implicit Price Deflator, is an inflation indicator

It is the ratio of the value of goods and services produced by an economy in a given year at current prices (nominal GDP) to the value of goods and services produced during the base year (Real GDP).

•   This proportion represents the amount of the ascent in GDP is because of rising costs rather than an expansion in yield
• The deflator is seen as a more complete indicator of inflation since it covers the entire spectrum of goods and services generated in the economy, as opposed to the narrow commodity baskets used in the wholesale and consumer price indexes

GDP price deflator = (nominal GDP ÷ real GDP) x 100

• As the name implies, it has the special goal of converting nominal GDP to real GDP by decreasing the effect on prices
• A price deflator of 50, for example, shows that the current year’s price is half that of the base year’s price – high inflation
• It is the broadest indicator of total pricing levels
• Changes in government expenditures, capital formation, foreign trade, and family consumption are all included

Importance of GDP Deflator:

• Unlike the Consumer Price Index (CPI), which primarily includes consumer goods, the GDP Deflator is seen to be a better estimate of GDP because it incorporates a larger basket of goods and services
• Without any change in the number of goods and services produced, price changes might give the appearance that GDP has increased or decreased, the deflator reveals the truth
• The problem with the metric is that it produces annualised figures in most nations, therefore the time lag in calculating the estimates could cause some distortions.
• GDP deflators are used to separate price from quantity rather than as an inflation indicator
• India utilises a quarterly deflator that combines the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) with a two-month lag
• The method we choose is determined by the estimate we’re seeking to deflate. Private consumption and government consumption will have distinct deflators
• Due to price fluctuations over time, the value of quarterly and year-end deflators differs
• We have an overall WPI/CPI measure at the end of the year that is used appropriately
•  GDP estimates towards the end of the year are more reliable than estimates at the beginning of the year

Conclusion

To summarise, the GDP can be calculated using three major methods, which are the income method, the expenditure method, and the value-added method. In this article, we discussed GDP calculation using various methods, such as the Real GDP formula, the Nominal GDP formula, GDP per capita, GDP Deflator, and so on. These formulas will aid in comprehending the concept of GDP calculation.