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One of the most important skills that you can develop during your study of Economics is the ability to work with statistics. If you can manipulate the data that you are provided, then you will be able to use it to make more meaningful decisions. One important process that you will need to learn is how to deflate statistics.

On the previous page, we examined an economy that appears to have grown by 23.75% from one year to the next. The problem, as we identified at the time, is that the price of the product made in that country has increased. To remind you, the situation in this country looked like this:


When prices increase in a country, we refer to this situation as inflation. The formal definition of inflation is a sustained increase in the general price level over a period of time. You will learn more about inflation soon. For now, we just need to know that when prices are increasing like this, we need to deflate the statistics that we generate in order to make meaningful comparisons.

To do this, there are several steps that you must follow:

1. Calculate the rate of inflation: In many cases you will be given the rate of inflation. In this case, we will need to work it out. The formula (at this stage) is:
   
   

   Value in Year 2 – Value in Year 1	x	100
   Value in Year 1		1

   
   This gives us the following:
   
   

   2.25 - 2.00	x	100	= 12.5%
   2.00		1

   
   
2. The inflation statistic that you have just calculated will now be used to deflate the figure for GDP that we calculated in the second year. What we are trying to do is express the value of the goods produced in year two in the prices that were used in year one. When we do that, we will be able to compare them. The formula looks like this:
   
   

   The Figure You Want To Deflate

   1 + The Rate of Inflation

   
   
   In this case, our formula will be:
   
   
   

   $247.50	(the value of GDP in market prices in year 2)
   1 + 0.125	(we calculated inflation to be 12.5%, which is equal to 0.125)

   
   
   Completing this calculation gives us a figure of $220.
   
   
3. We can now use this figure to examine whether or not the economy has grown. In the first year our GDP was $200. In the following year the deflated figure was $220. We can work out the percentage increase with one last formula:
   
   

   Deflated GDP Figure for Year 2 – Actual GDP Figure for Year 1	x	100
   Actual GDP Figure for Year 1		1

   
   
   This final calculation tells us that this simple economy has grown by 10% during this period.
   

This process is very similar to the actual process used by the Australian Bureau of Statistics when they are calculating economic growth in Australia. It has been used since 1998, and it is referred to as the chain volume measure of economic growth. This means that each year is “linked” to the previous year in order to determine the rate of growth.

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