Hence under the real income computation process we have removed the 25 percent effect of the rise in the price. Since to this extent we have deflated the value of nominal income, if we increase real income by 25 percent, once again we arrive at nominal income.

Thus we have 1920 + 25% = 1920 + 480 = 2400. Since real income on multiplication by deflator factor results into nominal income value it can also be called as conversion factor.

Deflator explains the rate of inflation. In the present case it is 25 percent. In a more systematic and general form rate of inflation can be stated as:

In our example the price P₁ is higher than P₀ and hence there is an inflationary rise in the price level by 25% during Y₀ to Y₁ years. This is a normal case. But in an exceptional year if the current price is lower than the base year price the deflator value will be less than 100 and the rate of inflation will be negative. In that case it is called rate of deflation. Therefore when the rate of inflation is positive, an inflationary rise in prices has occurred, but if the rate of inflation is negative the price level is said to have deflated.

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Index

3. 1 Macro Aggregates
3.2 Unemployment
3.3 Inflation

Chapter 4