Question

Can you give an example of the difference between the GDP deflator and CPI

1.GDP deflator reflects the prices of all goods produced domescally,whereas CPI reflects the price of all goods bought by consumers

And another example of

2.CPI is computed using a fixed basket ,whereas the gdp deflator allows the basket of goods change over time.

Answer 1

GDP deflator and consumer price index are two indices that enable track the rate of inflation in an economy. GDP inflator takes into account the price level changes or inflation in an economy during a given year. The price changes in the goods and services produced by businesses as well as the government are tracked along with the goods and services consumed by consumers. The CPI, on the other hand, tracks only the retail prices of goods and services at a particular time in a year. The changes, if any, in the costs of living of consumers are identified accordingly.

CPI uses a fixed basket of goods and services, thus ignoring changes in prices outside the basket. As such, the GDP deflator is a more effective measure of inflation as it isn't based on a fixed basket of goods and services; it measures the changes in prices of goods and services over a period of time.Changes in the consumption pattern or the introduction of new goods are taken into account by the GDP deflator, thus giving a more comprehensive view of the changes in economic variables like investment levels and even exports.

CPI includes prices of all the goods consumed by consumers, both domestic and foreign. The GDP deflator, on the othet hand, includes the prices of only domestic goods.

For example, suppose country A imports cars from Country B. The government of Country A decides to increase the import duties on cars. This move will increase the import price of cars for Country A and thus affect the consumption patterns of consumers in Country A, purchasing the cars imported from Country B. As such, the CPI shall be significantly affected but the GDP deflator will remain unaffected as it includes the prices of goods produced in the domestic country alone.

Another example of the difference between the CPI and the GDP deflator is as under:

Take a given time period, where there is a harvest boom in oranges in Florida. However, a killer frost captures Florida, destroying the large quantity of oranges. Consequently, the prices of the few remaining oranges in the markey will tend to increase. As the GDP deflator measures price changes during a specified time period, the resulting change in the prices of oranges will have no impact on the deflator; as the entire orange produce has been destroyed, GDP deflator will record the orange output at zero. However, as we are talking about a single point in time and also a fixed basket of oranges, CPI will reflect the price changes as the price increase will significantly impact the purchasing power of consumers.

(Reference: investopedia.com)