In: Economics
1. Suppose the data for a hypothetical economy is given above. This economy produces only 3 things, pizzas, haircuts and tanks. The base year is 2019.
Quantity of pizzas |
Quantity of haircuts |
Quantity of tanks |
Price of pizzas |
Price of haircuts |
Price of tanks |
|
2019 |
100 |
20 |
10 |
$10 |
$15 |
$150 |
2020 |
120 |
30 |
12 |
$10 |
$16 |
$120 |
a. Calculate GDP deflator in 2020. Based on GDP deflator, what is the inflation rate from 2019 to 2020?
b. Suppose a representative consumer basket consists of 10 pizzas and 20 haircuts. Using this consumer basket, calculate CPI in 2020 (again, assuming 2019 is the base year). Based on CPI, what is inflation rate
c. Why do you think there is such a dramatic difference in the inflation rates from parts a and b?
ANSWER:
Given that:
1. Suppose the data for a hypothetical economy is given above. This economy produces only 3 things, pizzas, haircuts and tanks. The base year is 2019.
(a)
Calculate GDP deflator in 2020. Based on GDP deflator, what is the inflation rate from 2019 to 2020
(i) Nominal GDP (NGDP) = \sum (Current year price x Current year quantity)
2019 = 10 x 100 + 15 x 20 + 150 x 10 = 1000 + 300 + 1500 = 2800
2020 = 10 x 120 + 16 x 30 + 120 x 12 = 1200 + 480 + 1440 = 3120
(ii) Real GDP (RGDP) = \sum (Base year (2019) price x Current year quantity)
2019 = 10 x 100 + 15 x 20 + 150 x 10 = 1000 + 300 + 1500 = 2800
2020 = 10 x 120 + 15 x 30 + 150 x 12 = 1200 + 450 + 1800 = 3450
(iii) GDP Deflator = (NGDP / RGDP) x 100
2019 = (2800 / 2800) x 100 = 100
2020 = (3120 / 3450) x 100 = 90.43
(iv) Inflation rate = % Change in GDP deflator = (90/43 / 100) - 1 = 0.9043 - 1 = - 0.0957 = - 9.57%
(b)
Suppose a representative consumer basket consists of 10 pizzas and 20 haircuts.
(i) CPI, year N = (Cost of basket, year N / Cost of basket, base year) x 100
Cost of basket, 2019 = 10 x 10 + 15 x 20 = 100 + 300 = 400
Cost of basket, 2020 = 10 x 10 + 16 x 20 = 100 + 320 = 420
CPI, 2019 = (400/400) x 100 = 100
CPI, 2020 = (420/400) x 100 = 105
(ii) Inflation rate = % Change in CPI = (105/100) - 1 = 1.05 - 1 = 0.05 = 5%
(c)
Why do you think there is such a dramatic difference in the inflation rates from parts a and b
Since GDP includes all domestically produced goods, tanks are included in computing NGDP and RGDP. But tanks are not used by households, so are excluded from CPI calculation. Therefore, inflation rates are different.