How is the GDP deflator calculated, and what does it indicate about price level changes?

• A. GDP deflator = (Nominal GDP / Real GDP) × 100; it measures the overall price level of domestically produced goods and services.
• B. The GDP deflator measures the price level of only consumer goods.
• C. The GDP deflator is identical to the CPI.
• D. The GDP deflator is computed using the prices of imports.

Answer: (A)

The GDP deflator is a broad price index that tracks how the overall price level for all final goods and services produced domestically has moved. It is calculated as nominal GDP divided by real GDP, times 100. This ratio shows how much prices have changed since the base year: if nominal GDP grows faster than real GDP, the deflator rises, signaling inflation in the prices of domestically produced goods and services. Unlike the CPI, which looks at a fixed basket of consumer goods, the GDP deflator covers all final domestically produced goods and services, including investment, government spending, and net exports, and it does not include imports. Because it uses current prices for the entire output, it reflects changes in the price level of what the economy actually produces, not just what consumers buy.