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What is GDP Deflator – Indian Economy UPSC Notes

GDP Deflator is a measure of price inflation or deflation within an economy.It reflects how much prices have changed since a base year.
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GDP Deflator 

The GDP Deflator is a measure of inflation that reflects how much the prices of goods and services produced in an economy have changed compared to a base year. It helps us understand whether the increase in GDP is due to higher production or just higher prices.

The GDP Deflator is a measure of price inflation or deflation within an economy. It reflects how much prices have changed since a base year and is used to convert Nominal GDP into Real GDP.

GDP Deflator Formula

GDP Deflator=(Nominal GDPReal GDP)×100\text{GDP Deflator} = \left( \frac{\text{Nominal GDP}}{\text{Real GDP}} \right) \times 100

Breaking it Down

  1. Nominal GDP: The GDP calculated using current year prices (includes inflation).
  2. Real GDP: The GDP calculated using base year prices (excludes inflation).

The GDP Deflator shows how much prices have changed over time relative to the base year.

Example: Bakery Shop

Imagine a small bakery produces 100 cakes in both 2020 (base year) and 2025.

  1. Prices of Cakes:

    • In 2020 (base year): Each cake costs ₹50.
    • In 2025: Each cake costs ₹60 (prices have increased).

  2. Production in Both Years: 100 cakes.

Step 1: Calculate Nominal GDP

  • Nominal GDP (2020) = 100 cakes × ₹50 = ₹5000.
  • Nominal GDP (2025) = 100 cakes × ₹60 = ₹6000.

Step 2: Calculate Real GDP (using 2020 prices)

  • Real GDP (2020) = 100 cakes × ₹50 = ₹5000.
  • Real GDP (2025) = 100 cakes × ₹50 = ₹5000.

Step 3: Apply the Formula

GDP Deflator (2025)=(Nominal GDP (2025)Real GDP (2025))×100\text{GDP Deflator (2025)} = \left( \frac{\text{Nominal GDP (2025)}}{\text{Real GDP (2025)}} \right) \times 100 GDP Deflator (2025)=(₹6000₹5000)×100=120\text{GDP Deflator (2025)} = \left( \frac{₹6000}{₹5000} \right) \times 100 = 120

What Does This Mean?

  • GDP Deflator = 120: Prices in 2025 are 20% higher compared to 2020 (base year).
  • This increase in Nominal GDP is entirely due to inflation since production hasn’t changed.

How It Works:

  • If the GDP Deflator is greater than 100, it indicates that prices have risen compared to the base year (inflation).
  • If the GDP Deflator is less than 100, it means prices have decreased compared to the base year (deflation).

Why Is GDP Deflator Important?

  1. Tracks Inflation: It shows the overall change in prices for all goods and services in an economy.
  2. Real vs. Nominal Growth: Helps distinguish whether economic growth is due to higher production or higher prices.
  3. Broader Measure: Unlike CPI or WPI, it covers all goods and services in GDP.
GDP Deflator

Summary

  • Nominal GDP includes inflation; Real GDP removes it.
  • GDP Deflator tells us how much prices have risen compared to a base year.
  • A GDP Deflator of 120 means prices are 20% higher than the base year.

Isn’t that simple? 😊

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