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The GNP deflator is a price index that is used to adjust GNP for inflation. It is important to do this because you need to adjust for inflation to calculate real GNP. Real GNP is GNP adjusted for inflation.
GNP (Gross National Product) is a measure of national income. It is the market value of all goods and services created in a given year by labor and property that belong to the citizens of a given country. This measure is similar to, but not the same as, GDP. One main reason for using GNP is to know how big our country’s economy is. But changes in GNP do not necessarily mean that our economy is growing. GNP does not measure how many goods and services are being produced. Instead, it measures how much the goods and services that are produced cost. This means that we could make the exact same number of goods and services this year as we did last year but we could still see GNP rise if the prices of the goods and services rose. It would look like the economy was growing because GNP rose, but in reality, the only thing that happened was an increase in prices (inflation).
To avoid this problem, we use the GNP deflator. It shows how much prices have risen since a base year. We use it to adjust the GNP (technically, this is “nominal GNP”) for inflation. Once we have done this, we have real GNP, which shows what our GNP is when adjusted for inflation.
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