The term gross domestic price deflator refers to a measure of the prices for all domestic goods and services produced in an economy. As is the case with the consumer price index, the gross domestic product (GDP) deflator measures the increase and decrease in the price of goods and services with respect to a base year.
GDP Deflator = (Nominal GDP / Real GDP) x 100
A price index is a benchmark measure that allows analysts to understand how the price of goods and / or services varies over time or between geographies. Broad based indices allow economists to understand how well an economy is performing and the impact of prices on the cost of living. Also referred to as the implicit price deflator, the gross domestic price deflator (GDP deflator) is used to adjust GDP values for inflation so it's possible to make accurate comparisons over time.
The calculation of the GDP deflator takes the nominal (current) GDP and divides it by the real (inflation adjusted) GDP in a reference year. The result is then multiplied by 100 so it can be directly compared to the base year, which will always be represented as 100. For example, a price deflator of 120 means current prices are 20% higher than the base year (an inflationary situation). If the price deflator is 80, then current prices are 20% lower than the base year (a deflationary situation).
Both the consumer price index (CPI) and GDP deflator measure inflation, and both typically move in lockstep; however, the GDP deflator is considered the superior measure. Since the CPI is based on a static set of goods and services, it does not account for changes in the price of goods and services not in the basket. The GDP deflator measures the prices of all domestically produced goods and services and therefore accounts for changes in consumption patterns too.