What is the GDP deflator?

Headline : What is the GDP deflator?

Details :

Gross Domestic product (GDP)

GDP and its calculation

  • Gross domestic product (GDP) is the market value of all final goods and services produced within the national borders of a country for a given period of time.
  • As per National Income Accounting there are 3 ways to compute GDP:
    1. Product wise: Calculating the total production of goods and services. Thus total money value added from each of the main economic sector.
    2. Expenditure wise: Calculating the total expenditure of all the entities.
    3. Income wise: Calculating the total incomes received by factors of production – labour & capital.
  • So, whichever way you take it, each of the estimates, should provide you the same GDP. But all these calculations have errors and in reality we never have one figure.

 

Output Approach

  • The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces.
  • Because of the complication of the multiple stages in the production of a good or service, only the final value of a good or service is included in the total output.
  • This avoids an issue referred to as double counting, where the total value of a good is included several times in national output, by counting it repeatedly in several stages of production.
  • Formula: GDP (gross domestic product) at market price = value of output in an economy in the particular year – intermediate consumption at factor cost = GDP at market price – depreciation + NFIA (net factor income from abroad) – net indirect taxes.

 

Expenditure Approach:

  • The expenditure approach attempts to calculate GDP by evaluating the sum of all final good and services purchased in an economy.
  • Formula: Y = C + I + G + (X – M); where: C = household consumption expenditures / personal consumption expenditures, I = gross private domestic investment, G = government consumption and gross investment expenditures, X = gross exports of goods and services, and M = gross imports of goods and services.

 

Income Approach:

  • The income approach equates the total output of a nation to the total factor income received by residents or citizens of the nation.
  • The main types of factor income are employee compensation, interest received net of interest paid etc.
  • Formula: GDI (gross domestic income, which should equate to gross domestic product) = Compensation of employees + Net interest + Rental & royalty income + Business cash flow

 

GDP deflator

Definition:

  • The GDP deflator, also called implicit price deflator, is a measure of inflation.
  • It is the ratio of the value of goods and services an economy produces in a particular year at current prices to that of prices that prevailed during the base year.
  • The formula to find the GDP price deflator: GDP price deflator = (nominal GDP ÷ real GDP) x 100

 

Real vs nominal GDP:

  • Nominal GDP differs from real GDP as the former doesn’t include inflation, while the latter does.
  • As a result, nominal GDP will most often be higher than real GDP in an expanding economy.
  • GDP price deflator measures the difference between real GDP and nominal GDP.

 

Significance:

  • This ratio helps show the extent to which the increase in gross domestic product (GDP) has happened on account of higher prices rather than increase in output.
  • Since the deflator covers the entire range of goods and services produced in the economy — as against the limited commodity baskets for the wholesale or consumer price indices — it is seen as a more comprehensive measure of inflation.
  • Changes in consumption patterns or introduction of goods and services are automatically reflected in the GDP deflator. This allows the GDP deflator to absorb changes to an economy’s consumption or investment patterns.

 

Comparison with other inflation measurement:

  • CPI and WPI:
    • A consumer price index (CPI) measures changes over time in the general level of prices of goods and services that households acquire for the purpose of consumption.
    • However, since CPI is based only a basket of select goods and is calculated on prices included in it, it does not capture inflation across the economy as a whole.
    • The wholesale price index (WPI) basket has no representation of the services sector and all the constituents are only goods whose prices are captured at the wholesale/producer level.
  • GDP deflator:
    • Specifically, for the GDP deflator, 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. Often, the trends of the GDP deflator will be similar to that of the CPI.
    • Therefore, new expenditure patterns are allowed to show up in the deflator as people respond to changing prices. The theory behind this approach is that the GDP deflator reflects up-to-date expenditure patterns.
  • GDP deflator is available only on a quarterly basis along with GDP estimates, whereas CPI and WPI data are released every month.

 

Additional information:

GDP vs GVA:

Gross value added (GVA)

  • It is a measure of total output and income in the economy. It provides the rupee value for the amount of goods and services produced in an economy after deducting the cost of inputs and raw materials that have gone into the production of those goods and services.
  • It also gives sector-specific picture like what is the growth in an area, industry or sector of an economy.

 

Difference between GDP and GVA:

  • While GVA gives a picture of the state of economic activity from the producers’ side or supply side, the GDP gives the picture from the consumers’ side or demand perspective.
  • Both measures need not match because of the difference in treatment of net taxes.

 

Net taxes: All indirect taxes and subsidies has been divided into two parts:

  • Production taxes or subsidies: Production taxes or subsidies are paid or received with relation to production and are independent of the volume of actual production. Some examples are:
    1. Production Taxes – Land Revenues, Stamps and Registration fees and Tax on profession
    2. Production Subsidies – Subsidies to Railways, Input subsidies to farmers, Subsidies to village and small industries, Administrative subsidies to corporations or cooperatives, etc.
  • Product taxes or subsidies – Product taxes or subsidies are paid or received on per unit of product. Some examples are:
    1. Product Taxes: Excise Tax, Sales tax, Service Tax and Import and Export duties
    2. Product Subsidies: Food, Petroleum and fertilizer subsidies, Interest subsidies given to farmers, households etc through banks, Subsidies for providing insurance to households at lower rates
  • GVA at factor cost (earlier GDP at factor cost) = GVA at basic prices – production taxes + production subsidies
  • GDP = Σ GVA at basic prices + product taxes – product subsidies

 

Significance of GVA

  • At the macro level, from national accounting perspective, it is the sum of a country’s GDP and net of subsidies and taxes in the economy. When measured from the production side, it is a balancing item of the national accounts.
  • A sector-wise breakdown provided by the GVA measure can better help the policymakers to decide which sectors need incentives/stimulus or vice versa.
  • Some consider GVA as a better gauge of the economy because a sharp increase in the output, only due to higher tax collections which could be on account of better compliance or coverage, may distort the real output situation.

 

 

Section : Economics

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