GDP Deflator vs Nominal GDP
GDP Deflator and Nominal GDP are two Measuring the Economy concepts in AP Economics that students often mix up. The GDP deflator is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. Nominal GDP is the value of all final goods and services produced in a given year, evaluated at current-year prices. Here is how they compare side by side.
It is calculated as the ratio of nominal GDP to real GDP, multiplied by 100, and shows how much prices have changed since the base year. It is a broad measure of inflation that includes all goods and services in GDP, unlike the CPI which uses a fixed basket.
It reflects changes in both quantity and price levels, so increases can result from inflation rather than actual growth in output. It is not adjusted for changes in the price level and can overstate economic growth during inflationary periods.
GDP Deflator vs Nominal GDP: A Price Index Against a Dollar Total
| GDP Deflator | Nominal GDP | |
|---|---|---|
| What it reports | The average price of domestically produced output | The dollar value of domestically produced output |
| Units | An index number with no units, base period set to 100 | Currency, usually billions of dollars |
| Effect of more output at steady prices | No change | Rises |
| What a 10 percent rise in it tells you | Domestic output costs 10 percent more than in the base period | The dollar value of output is 10 percent larger, from prices or quantities or both |
| How it is built | Nominal GDP divided by real GDP, times 100 | Every final quantity multiplied by the price charged that year |
| What it is used for | Converting nominal figures into real ones | Comparing output with debt, deficits and other current dollar totals |
| Which one an inflation question wants | This one, since it isolates price change | Not this one, since price and quantity are mixed together |
One is a dollar total, the other is the price tag attached to that total
Nominal GDP answers how many dollars of final output an economy produced. The GDP deflator answers what happened to the average price of that output. Run the numbers on a two good economy. In the base period it makes 100 loaves at $2 and 50 shirts at $10, so nominal GDP is $200 plus $500, or $700, and the deflator is set at 100. In the next period it makes 110 loaves at $2.20 and 52 shirts at $11, so nominal GDP is $242 plus $572, or $814. Value those new quantities at base period prices instead and real GDP is 110 times $2 plus 52 times $10, or $740. The deflator is $814 divided by $740, times 100, which comes to 110. Now read the three growth rates side by side. Nominal GDP rose 16.3 percent, the deflator rose 10 percent, and real output rose 5.7 percent. The first figure is roughly the sum of the other two because it contains both of them, and that is the whole relationship between the pair: one number stacks price change on top of quantity change, and the other strips the quantity change back out.
Which number to reach for, and the trap it sets
Reach for nominal GDP whenever the comparison is against another current dollar figure, such as government debt, tax revenue or a deficit, because both sides of that ratio are then measured in the same period's money. Reach for the deflator whenever price change has to come out, since real GDP equals nominal GDP divided by the deflator, times 100. The trap is reading a rise in nominal GDP as evidence that a country produced more. An economy with 12 percent nominal growth and a deflator up 12 percent produced nothing extra at all, while one with 3 percent nominal growth and a deflator down 1 percent produced about 4 percent more. Exam questions usually hand over two of the three quantities and ask for the third, so hold the identity in one form: nominal equals real times the deflator over 100. A second point separates this index from the consumer price index. The deflator covers everything counted in domestic output, machinery and buildings and government services included, and it excludes imports entirely, while the consumer index tracks a fixed basket bought by households and does include imported items. A jump in imported oil prices therefore hits the consumer index first and reaches /glossary/gdp-deflator only through whatever domestic production uses that oil.
Frequently asked questions
Is the GDP deflator the same thing as nominal GDP?
No. Nominal GDP is a dollar total that rises when prices rise, when output rises, or when both do. The GDP deflator is an index number with no units that rises only with the average price of domestic output. They are linked by an identity rather than being versions of each other: the deflator equals nominal GDP divided by real GDP, times 100.
How do you calculate the GDP deflator from nominal and real GDP?
Divide nominal GDP by real GDP and multiply by 100. Using the worked figures above, $814 of nominal GDP against $740 of real GDP gives 814 divided by 740, times 100, or 110. A reading of 110 says the average price of output is 10 percent above the base period. The same identity rearranges to give real GDP as nominal GDP divided by the deflator, times 100.
Can nominal GDP rise while the GDP deflator falls?
Yes, and that combination means real output grew faster than the headline dollar figure suggests. If nominal GDP rises 3 percent while the deflator falls 1 percent, real output rose about 4 percent, because 1.03 divided by 0.99 is 1.04. Falling prices with rising physical production is the usual cause, and it is the one case where the nominal figure understates rather than overstates real growth.
Related comparisons
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