An estimate of an average price level relative to the price level in a chosen base period. In general, the implicit price deflator for an economic series is calculated by dividing a nominal value for that series by its real value measured in terms of some base period. Taking private consumption as an example and 1996 as the year under review, an implicit price deflator is calculated in three steps:
1. Consider the dollar value of private consumption in 1996 - this is the quantity of every item consumed in 1996, each multiplied by its price in 1996 with the resulting dollar values added for all items. This result can be called 'nominal' consumption in 1996 (it is in fact the total value of consumption recorded in the National Accounts).
2. Multiply the quantity of every item consumed in 1996 by the price at which that item sold in some base year, say, 1989. This revalues the 1996 consumption items in terms of 1989 prices. call this result 'real' consumption in 1996 (Q).
3. Imagine that there is an average price, P, of all commodities consumed in 1996. Then nominal consumption can be thought of as the average price P multiplied by the real amount consumed, Q, (ie, dollar value of consumption = P x Q). Dividing P x Q by real consumption Q must yield the average price, P. This is called the 1996 implicit price deflator for consumption where 1989 is the base year (usually the result is multiplied by 100 and written as P = 120 where 1989 = 100, ie, showing that this estimate of the average price of consumed commodities has risen 20 per cent since 1989).
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