Question

Year       Cauliflower         Broccoli                   Carrots

               P      Q                     P          Q                 P               Q

2013       $2     100             $1.50     25                $0.10         450

2014       $3      120             $1.50    50                 $0.20         550

2013 is the base year. The BLS quantity number is 100 cauliflower   50 broccoli    500 carrots

In the text box below SHOW ALL WORK for questions 1 & 2 and underline answers for both years, CPI and Inflation Levels and GDP Deflator and Inflation Levels. Answer Question 3 by using what you have learned about the differences in the two methods.

1)Find the basket costs for 2013 and 2014; calculate the Consumer Price index for each year; calculate the rate of inflation from 2013 to 2014. Underline your answers for the Consumer Price Index and the rate of inflation.   

2)Find the Nominal GDP and Real GDP for 2013 and 2014; Calculate the GDP Deflator for 2013 and 2014; find the rate of inflation from 2013 to 2014. Underline your answers for GDP Deflators and the inflation rate.

3) Are your inflation rates the same in each approach? Why or why not? Use the ABCD method to help you in the analysis.

I'm looking for a thorough breakdown of what came where in answering this question. If anyone is up for the challenge, please help me figure this out. Thank you

Answer 1

Answer : Given that 2013 is the base year. For given BLS quantities :

1) For 2013 :

Basket cost = (100 * 2) + (50 * 1.50) + (500 * 0.10) = 200 + 75 + 50 = 325

For 2014 :
Basket cost = (100 * 3) + (50 * 1.50) + (500 * 0.20) = 300 + 75 + 100 = 475

CPI of 2013 = [Current year basket cost / Base year basket cost] * 100

=> CPI of 2013 = [325 / 325] * 100

=> CPI of 2013 = 100

CPI of 2014 = [Current year basket cost / Base year basket cost] * 100

=> CPI of 2014 = [475 / 325] * 100

=> CPI of 2014 = 146.15

Inflation rate = [(CPI of 2014 - CPI of 2013) / CPI of 2013] * 100

=> Inflation rate = [(146.15 - 100) / 100] * 100

=> Inflation rate = 46.15%

Therefore, the inflation rate between 2013 and 2014 is 46.15%.

2) For given BLS quantities :

For 2013 :

Nominal GDP = Current year basket cost = (100 * 2) + (50 * 1.50) + (500 * 0.10) = 200 + 75 + 50 = 325

Real GDP = Base year basket cost = (100 * 2) + (50 * 1.50) + (500 * 0.10) = 200 + 75 + 50 = 325 [As base year is 2013]

GDP deflator of 2013 = [Nominal GDP / Real GDP] * 100

=> GDP deflator of 2013 = [325 / 325] * 100

=> GDP deflator of 2013 = 100

For 2014 :

Nominal GDP = (100 * 3) + (50 * 1.50) + (500 * 0.20) = 300 + 75 + 100 = 475

Real GDP = (100 * 2) + (50 * 1.50) + (500 * 0.10) = 200 + 75 + 50 = 325

GDP deflator of 2014 = [Nominal GDP / Real GDP] * 100

=> GDP deflator of 2014 = [475 / 325] * 100

=> GDP deflator of 2014 = 146.15

Inflation rate = [( GDP deflator of 2014 -  GDP deflator of 2013) /  GDP deflator of 2013] * 100

=> Inflation rate = [(146.15 - 100) / 100] * 100

=> Inflation rate = 46.15%

Therefore, the inflation rate between 2013 and 2014 is 46.15%.

3) Yes, we get the same inflation rate by using CPI approach and GDP deflator approach.

CPI and GDP deflator both are the measures of inflation rate. Because for CPI calculation we divide the current year basket cost by base year basket cost and then multiply by 100. And for GDP deflator we divide nominal GDP which is the current year basket cost by the real GDP which is the base year basket cost then multiply by 100. As CPI and GDP deflator both uses the same basket costs, hence the resultant outcome is same and inflation rate is same.