Implicit GNP Price Deflator

Categories: Econ

There are price deflators, like...things that would bring down something's price. Think: two-day-old sushi. Or Christmas ornaments on December 26th. Or a prize show dog that suddenly loses all it’s hair.

But that's not the kind of price deflator we have in mind here.

The GDP price deflator is a measure of prices for goods and services produced within a country for a period of time. It's a way to track inflation.

Example time.

Snowhaven is a tiny country located to the north of Greenland. The nation boasts 120 residents, each of whom makes a living from the production and export of ice sculptures. You're an Econ PhD student working on a thesis. Your roommate threw a party the day before you were scheduled to declare your thesis topic. You don't remember much, but somehow you ended up with a thesis topic centered on the economy of Snowhaven.

You start your research. First step, calculate how big Snowhaven's economy is. Simple stuff. To measure economic output, you use GDP, or Gross Domestic Product, a broad measure of economic production. See: GDP. You calculate that figure by adding up the value of all the goods and services produced by an economy during a period of time. In Snowhaven, where everyone just makes ice sculptures, you're dealing only with the value of all the ice sculptures they make.

In a more complex economy, like the U.S., you're dealing with a lot more things. So all the value of ski-doos and juicers and Oreos that get made in a year, as well as the value of all the yoga classes and foot massages...gets added up. Notice that the word "value" keeps coming up. You don't count the number of goods made, or the number of services rendered. You count the value of the goods and services. Like...the dollar value. If you just counted the number of goods, then making a bar of soap would count the same as making a passenger jet. The soap is one thing. The jet is one thing. But obviously more goes into making the jet. A bunch more people have to work a lot more to get that jet made. It should count more in GDP. So...to give everything the proper weighting in the GDP figure, the currency value of the stuff gets added together. The soap contributes 50 cents to GDP. The jet contributes $380 million.

But there's an issue that comes up with this method. GDP gets impacted by price changes. Meaning that inflation gets counted as growth. Prices rise, GDP rises. Whether or not actual output goes up.

This year, the people of Snowhaven made 20,000 ice sculptures, which sold for an average price of $1,000 each. $1,000 times 20,000...$20 million. GDP for the year was $20 million. Next year, they also make 20,000 sculptures. But there’s a wave of high-class art galas in Monaco that needs ice sculptures...and that drives prices higher. Average price rises to $1,100. Plug that into the GDP equation. Total GDP: $22 million. 10% GDP growth. But all of that was from inflation.

Ideally, as an economist, you want to be able to tell how much changing prices contribute to GDP growth. That way, you can get an accurate picture of what's going on in the economy without inflation mucking up the situation. For that reason, there are actually two GDP measures. There's nominal GDP, i.e. the number we just figured out. It's the raw number that includes the price changes. And then there's real GDP. It's an adjusted number, where the impact of price changes get stripped out.

Here’s where the implicit GDP price deflator comes in. It represents the ratio between nominal GDP and real GDP. It shows the impact that inflation had on GDP that year.

So Snowhaven has nominal GDP of $22 million for the year. But $2 million of that came from price changes. The country's real GDP totals $20 million. Nominal GDP over real GDP...$22 million over $20 million. The implicit GDP price deflator for the year is 1.1.

A number above 1 on the deflator figure means prices went up during the period. In other words, inflation. The higher the number, the higher the rate of inflation.

A number below 1 means real GDP was higher than nominal GDP, and indicates a drop in general prices. Deflation.

Like when your suddenly bald, former prize show dog also develops a painful infectious skin disease and starts to show early signs of rabies...

Related or Semi-related Video

Econ: What is Implicit GNP Price Deflato...0 Views

00:00

And finance Allah shmoop What is implicit GDP price deflator

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Okay people there are price deflator is like you know

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things that would bring down something's price Think two day

00:15

old sushi or Christmas ornaments on sale December twenty sixth

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for a prize show dog that suddenly loses all its

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air Well that's not kind of price deflator we have

00:26

in mind here The GDP price deflator is a measure

00:29

of prices for goods and services produced within a country

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for a period of time It's a way to basically

00:35

track inflation in that country Snow Haven is a tiny

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country located to the north of Greenland The nation boasts

00:45

one hundred twenty residents total each of whom makes a

00:48

living from the production and export of ice sculptures You're

00:51

a Nikon Ph D student working on a thesis Your

00:54

roommate threw a party the day before you were scheduled

00:56

to declare your thesis topic You don't remember much but

00:59

somehow you ended up with a thesis topic centered on

01:01

the economy of snow haven Will you start your research

01:04

first step Calculate how big snow havens economy is Alright

01:08

that's pretty simple To measure economic output Used GDP gross

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domestic product A broad measure of economic production right You

01:14

know what that is You calculate that figure by adding

01:17

up the value of all the goods and services produced

01:19

by an economy during a period of time Well in

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snow havens case where everyone just makes ice sculptures you're

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dealing only with the value of all the ice sculptures

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they make In a more complex economy Like while the

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U S You're dealing with a whole lot more things

01:32

right So all the value of ski news and juicers

01:34

and Oreos that get made in a year as well

01:36

is the value of all the yoga classes and foot

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massages they get done Yet all gets added up will

01:42

notice that the word value keeps coming up here You

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don't count the number of goods made or the number

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of services rendered You count the value of those goods

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and services like the dollar value of them If you

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just counted the number of goods like the volume well

01:56

then making a bar of soap might count the same

01:59

as making a passenger jet right one for one it

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doesn't quite work The soap is one thing The jets

02:04

another but obviously more goes into making the jet and

02:06

a bunch More people have to work a lot more

02:08

to get that jet made so it should count a

02:10

lot more to GDP right has more value than a

02:12

bar So so to give everything the proper waiting in

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the GDP figure the currency value of the stuff gets

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all out of together The soap contributes Ah fifty cents

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of GDP and the jet contributes an thirty eight million

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But there's an issue that comes up with this method

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GDP gets impacted by price changes meaning inflation gets counted

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as growth prices rise GDP rise is whether or not

02:35

actual output goes up We have to adjust for that

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So this year the people of Snow Haven made twenty

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thousand ice sculptures which sold for an average price of

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a thousand bucks each The math Well that's a thousand

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times twenty thousand or twenty million dollars GDP for the

02:48

year for Snow Haven Yep twenty meg and next year

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they also make twenty thousand sculptures But there's a wave

02:54

of high class art Gallas in Monaco that you know

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needs ice sculptures so that drives the prices higher Average

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price rises to a thousand one hundred dollars each while

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we plug that into the GDP equation and that totals

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of GDP of twenty two million dollars That's ten percent

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GDP growth Massive But all that growth was just from

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inflation And yes it could be pricing power of the

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supplier Ah got higher because they're ice sculptures were more

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in demand and more highly prized But that's not where

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this question's going We're going to say it's on ly

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by inflation that you know prices went up on that

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was kind of it So ideal is an economist You

03:32

want to be able to tell how much changing prices

03:35

contribute to the GDP growth That way you can get

03:38

an accurate picture of what's going on in the economy

03:40

without inflation mucking up the whole situation So for that

03:43

reason there are actually two GDP measures There's nominal GDP

03:47

I even number We just figured out the name of

03:50

the GDP the name of that number It's the raw

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number that includes the price changes And then there's really

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GDP It's an adjusted number where the impact of price

03:59

changes get well soon tricked out Here's where the implicit

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GDP price deflator comes in Then it represents the ratio

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between nominal GDP and riel GDP It shows the impact

04:09

that inflation had on GDP that year so Snow Haven

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has nominal GDP of twenty two million bucks for the

04:15

year But two million of that came from price changes

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so the country's riel GDP was twenty million nominal GDP

04:22

over real GDP twenty two million over twenty million The

04:25

implicit GDP price deflator for the year then yes one

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point one a number above one on the deflator figure

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means prices went up during the period We're going to

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divide by that number and bring him down to the

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real number In other words there was inflation the higher

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the number while the higher the rate of inflation Yeah

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a number below one means that real GDP was higher

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than nominal GDP indicating a drop in general prices like

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deflation Like when you're suddenly evolved Former prize show dog

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also developed a painful infectious skin disease and starts to

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show early signs of rabies Yeah run for the hills 00:05:01.37 --> [endTime] people Yeah

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