GDP deflator

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In economics, the GDP deflator (implicit price deflator for GDP) is a measure of the change in prices of all new, domestically produced, final goods and services in an economy. GDP stands for gross domestic product, the total value of all goods and services produced within that economy during a specified period.

The GDP deflator is not based on a fixed market basket of goods and services. The basket is allowed to change with people's consumption and investment patterns. Therefore, new expenditure patterns are allowed to show up in the deflator as people respond to changing prices.

1 Calculation
- 1.1 Measurement in National Accounts
- 1.2 United States
2 Hedonics
3 See also
4 External links
- 4.1 Data
- 4.2 Hedonics

[edit] Calculation

[edit] Measurement in National Accounts

In most systems of National Accounts the GDP deflator measures the difference between the real (or chain volume measure) GDP and the nominal (or current price) GDP. The formula used to calculate the deflator is:

$\operatorname{GDP\ deflator} = \frac{\operatorname{Nominal\ GDP}}{\operatorname{Real\ GDP}}\times 100$

Dividing the nominal GDP by the GDP deflator would then give the figure for real GDP, hence deflating the nominal GDP into a real measure.

It is often useful to consider implicit price deflators for certain subcategories of GDP, such as computer hardware. In this case, it is useful to think of the price deflator as the ratio of the current-year price of a good to its price in some base year. The price in the base year is normalized to 100. For example, for computer hardware, we could define a "unit" to be a computer with a specific level of processing power, memory, hard drive space and so on. A price deflator of 200 means that the current-year price of this computing power is twice its base-year price - a price inflation. A price deflator of 50 means that the current-year price is half the base year price - a price deflation.

Unlike a price index, the GDP deflator is not based on a fixed basket of goods and services. The basket is allowed to change with people's consumption and investment patterns. (Specifically, for GDP, the "basket" in each year is the set of all goods that were produced domestically, weighted by the market value of the total consumption of each good.) Therefore, new expenditure patterns are allowed to show up in the deflator as people respond to changing prices. The advantage of this approach is that the GDP deflator measures changes in both prices and the composition of the basket - i.e. as prices and consumer preferences change, the GDP deflator accurately tracks both automatically. For this reason, the GDP deflator is in most ways a more accurate, and thus ideal measure of pure price changes in the overall economy. However, this also makes the GDP deflator less than desirable from a political and policy standpoint, as it cannot be manipulated in any way to reflect subjective preferences regarding what goods are 'most important' to measure when figuring an inflation rate. The U.S. government's Consumer Price Index (CPI) can be viewed, from the government's standpoint, as more desirable in this regard, even if it is probably less accurate.

In practice, the difference between the deflator and a price index like the CPI is often relatively small. Thus using one or the other is considered an esoteric concern by most economists. On the other hand, with governments in developed countries increasingly utilizing price indices for everything from fiscal and monetary planning to payments to social program recipients, the differences between an accurate measure of inflation and an inaccurate one can mean millions or billions of dollars that governments may not have to spend, or that social program recipients in the aggregate should recieve.

[edit] United States

The GDP and GDP deflator are calculated by the Bureau of Economic Analysis (BEA).

[edit] Hedonics

A hedonic price index for a specific good is based on the price of the good's various characteristics. For example, hedonic price indices are often applied to computers. The price of a computer can be explained as the price of its processor speed, memory, hard drive capacity, and so on. Hedonic price indices can vary over time as the prices of the underlying characteristics change.

In recent years, some commentators have expressed concern that the national accounts may overstate spending on computer hardware because of the way the hedonic price index and implicit price deflator are used. It is well-known that the prices of a unit of processor speed, a unit of memory, and a unit of hard drive capacity have declined very quickly since 1995. Therefore, the current-year (say, 2003) price deflator for an entire computer - using the hedonic method - is less than one relative to a base year of 1995. This means that when nominal spending on computer hardware is divided by the deflator to give real spending on computers, the number rises. (The "deflator" here is actually an inflator!) From the second quarter of 2000 through the fourth quarter of 2003, the government estimated that real tech spending rose from $446 billion to $557 billion, when nominal spending only increased to $488 billion. Some analysts feel that this overstates the "true" spending on computers by $72 billion. However, it is also true that this extra $72 billion captures the increase in value and utility of the computers that were purchased in 2003 as compared to 2000, due to the former's superior quality and capability for the same nominal price as the latter.

It can also be argued that abandoning use of the hedonic price index in this way, and simply relying on the GDP deflator, would also accurately reflect this increase in value and utility, though with less complication. The GDP itself would tend to increase over the same period (via greater productivity), at some level reflecting the greater capability better computers brought to the economy, and the deflator would simply record the real price increase of computers themselves.