Question

A small nation of 10 people idolizes the TV show The Voice. All they produce and consume are karaoke machines and CDs, in the following amounts: Karaoke Machines CDs Quantity Price Quantity Price (Dollars) (Dollars) 2017 20 50 60 5 2018 21 70 80 6 Using a method similar to that used to calculate the consumer price index, the percentage change in the overall price level is . (Note: Use 2017 as the base year, and fix the basket at 2 karaoke machine and 6 CDs.) Using a method similar to that used to calculate the GDP deflator, the percentage change of the overall price level is . (Note: Again, use 2017 as the base year.) Which of the following statements is correct? Check all that apply. The inflation rate in 2018 is not the same using the two methods. The GDP deflator allows the basket of goods and services to change. The CPI allows the basket of goods and services to change.

Answer 1

The cost of the market basket in 2017:

(2* 50) + (6 * 5) = $100 + $30 = $130.

The cost of the market basket in 2018:

(2* 70) + (6 * 6) = $140 + $36 = $176

Using 2017 as the base year, we will ccalculate the CPI in each year:

2017: (130/130) * 100 = 100

2018: (176/130) * 100 = 135.38

We can use the CPI to calculate the inflation rate for 2018

Inflation rate for 2018 =(135.38 − 100)/100 * 100 = 35.38%

Nominal GDP for 2017 = (20 *50) + (60*5) = $1000 + $300 = $1300

Nominal GDP for 2018= (21 *70) + (80 *6) = $1470 + $480 =$1950

Real GDP for 2017 = (20 *50) + (60*5) = $1000 + $300 = $1300

Real GDP for 2018 = (21 *50) + (80 *5) = $1050 + $400 = $1450

The GDP deflator for 2017 = (1300/1300) * 100 = 100

The GDP deflator for 2018 = (1950/1450)*100 = 134.48

The rate of inflation for 2018 = (134.48 – 100)/100 * 100 = 34.48%.

The correct statements are:

The inflation rate in 2018 is not the same using the two methods.

The GDP deflator allows the basket of goods and services to change.