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Monetary Policy - Inflation - Causes
Further work - GDP in real terms
GDP at constant prices
A part of the increase in GDP each year will be simply because prices have risen. The increase including the impact of inflation is called the 'money' increase in GDP. However, to see how much GDP has really grown we want to take out the effect of this inflation.
If we want to get GDP at constant prices between two years, we can use the Consumer Price Index (or the RPI if desired) for each year and the following formula:
| Real GDP (for year x) = | Money GDP (for year x) x | Consumer Price Index (for base year) |
| | | Consumer Price Index (for year x) |
GDP deflator
When calculating GDP in real terms the conventional measure of inflation (the Consumer Price Index) is not used. This is because the Consumer Price Index just measures the change in consumer prices, but GDP is made up of various other components as well. The GDP deflator takes account of price changes in all these other components. GDP is made up of consumption, investment, government expenditure and net spending on exports, and so the GDP deflator measures price changes in all these things.
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