Question

Consider a world in which there are just three goods: teepees, tobacco, and corn. Listed below are the prices and quantities of these goods produced in the base year and in the current year.

		All Goods Sold in US	All Goods Sold in US		Goods Consumed by Typical Consumer	Goods Consumed by Typical Consumer
		Base Year	Current Year		Base Year	Current Year
Teepees
	price	4	4		4	8
	quantity	200	200		5	2
Tobacco
	price	4	3		4	3
	quantity	0	200		0	5
Corn
	price	2	8		4	8
	quantity	300	200		15	10

Using the GDP Deflator calculation, between the base year and the current year there has been

		Inflation of approximately 25%
		Deflation of approximately –20%
		Inflation of approximately 50%
		No change in the price level

level

Answer 1

GDP Deflator in the base year = 100

Nominal GDP of the current year = Price of Teepees in the current year * Qty of Teepees in current year + Price of Tobacco in the current year * Qty of Tobacco in current year + Price of corn in the current year * Qty of corn in current year = $4 * 200 + $3 * 200 + $8 * 200 = $3,000

Real GDP of the current year = Price of Teepees in the base year * Qty of Teepees in current year + Price of Tobacco in the base year * Qty of Tobacco in current year + Price of corn in the base year * Qty of corn in current year = $4 * 200 + $4 * 200 + $2 * 200 = $2,000

GDP deflator in the current year = (Nominal GDP/Real GDP) * 100 = ($3,000/$2,000) * 100 = 150

Inflation between the base year and the current year = [(GDP Deflator in the current year-GDP Deflator in the base year)/GDP deflator in the base year] * 100 = [(150-100)/100] * 100 = 50%

Ans: Inflatiopn of approximately 50%