Question

This problem set counts 25% to the total mark. All questions have equal weight. Due date Thursday October 15th 2020 (end of week 7). Please upload in SafeAssign.

1. Comment on the differences between measuring inflation by the GDP de- flator and the CPI. Country Alpha relies heavily on its export industry. Why could that cause the inflation based on the GDP deflator and the CPI inflation to differ? Country Beta is completely self sufficient and has no governments spending. Why could the two inflation rates still differ?

Answer 1

1. Inflation can be defined as the general rise in price of goods and services during a specific period, usually one year. Inflation can be calculated using GDP deflator and CPI. However, the inflation rate so calculated is different in both methods.

GDP deflator takes into account all the final goods and services produced in the geographical boundaries of a country whereas the CPI considers only a fixed basket of goods and services that are predominantly consumed by the people. Thus GDP deflator excludes imports and includes exports whereas CPI may include import and excludes export.

For country Alpha, the inflation based on GDP deflator will be different than inflation based on the CPI. This is because most of the goods and services are exported (export oriented economy) and exported items are included in GDP deflator but not in CPI.

For country Beta, the inflation based on GDP deflator will be different than inflation based on the CPI. This is because although country is self sufficient i.e. there is no import and export, all goods and services are included in for calculation of GDP deflator but only specific goods and services are included for calculation of CPI.