What does the GDP deflator specifically measure?

The GDP deflator measures the level of prices of all domestically produced final goods and services. It is an important indicator in macroeconomics because it provides a broad measure of inflation within an economy. Unlike other indices such as the Consumer Price Index (CPI), which focuses on a basket of goods and services commonly purchased by households, the GDP deflator encompasses all goods and services included in the GDP.

This comprehensive measure allows economists to determine real GDP by adjusting for price changes over time, which is essential for analyzing the true growth of the economy without the distortions introduced by inflation. The GDP deflator is calculated by dividing nominal GDP— which is measured in current prices— by real GDP, then multiplying by 100. This calculation effectively captures how much prices have increased or decreased in the economy compared to a base year, reflecting overall economic activity and price stability.

The other choices focus on different aspects of economic measurement which do not pertain specifically to the price level of all domestically produced goods and services. For example, the total level of consumption, the annual growth rate of GDP, and the balance of trade each provide important insights, but they do not specifically measure the comprehensive price level across the entirety of domestic production like the GDP deflator