Question

Choose only ONE of the following to write your post (minimum of 200 words, maximum of 500 words)

Most economies around the world make efforts to always keep their inflation levels low. Although too much inflation is considered bad for an economy, the opposite of inflation, deflation, is considered even worse. You learned that deflation happens when most prices in the economy are falling. Do a brief research on the internet and explain why deflation is so bad for any economy, providing at least to 2 reasons.

This week you learned two ways to calculate inflation, CPI and GDP Deflator. Both of them have its peculiarities and drawbacks. But in your opinion, which one would be a better way to measure inflation in an economy? Provide at least 2 arguments to justify your choice.

Answer 1

GDP Deflator is generally considered to be a better measure for inflation calculation, there are multiple reasons for that first being GDP Deflator takes into account the price change of all the goods originating from the economy while CPI only takes a basket as price measure, having all goods solve problem of substitution which we have in basket since as price increase people shift to substitute product and this is not dynamically captured in price basket,also consumption change because of technological advancement like higher service life of products and all which affects the CPI basket price is captured completely with the GDP Deflator. Further GDP Deflator capture the price change of all the product and volume of production solves the issue of correct weight in baskets as we have the issue with CPI as a inflation measure tool. Issue with GDP Deflator that it does not take into account the price changes of imports is generally marginalised since the imported product price will tend to move in accordance to domestic produce otherwise those products won't be competitive in the domestic market, further these products generally have small weightage in the CPI too. So, Overall GDP Deflator appears to be more accurate tool for inflation calculation within national boundary.