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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

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

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

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

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.

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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