Question

LounchPod • Consider an economy that produces and consumes hot dogs and hamburgers. In the following table are data for two different years.

 a. Using 2010 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit price deflator for GDP, and a fixed-weight price index such as the CPI.

 b. By what percentage did prices rise between 2010 and 2015? Give the answer for each good and also for the two measures of the overall price level. Compare the answers given by the Laspeyres and Paasche price indexes. Explain the difference.

Answer 1

Part-a) Nominal GDP Year - 2010: $1,000
Nominal GDP Year - 2015: $3,000
Real GDP Year - 2010: $1,000
Real GDP Year - 2015: $2,000
GDP Deflator Year - 2010: 100
GDP Deflator Year - 2015: 150
CPI Year - 2010: 100
CPI Year - 2015: 160
Working:
Nominal GDP Year - 2010: = 200 * $2 + 200 * $3 = $1,000
Nominal GDP Year - 2015 = 250 * $4 + 500 * $4 = $3,000
Real GDP Year - 2010: $1,000
Real GDP Year - 2015: 250 * $2 + 500 * $3 = $2,000
GDP Deflator Year - 2010 = ($1,000/$1,000) * 100 = 100
GDP Deflator Year - 2015 = ($3,000/$2,000) * 100 = 150
CPI Year - 2010: {(200 * $2 + 200 * $3)/(200 * $2 + 200 * $3)} * 100 = 100
CPI Year - 2015: {(200 * $4 + 200 * $4)/(200 x $2 + 200 x $3)} * 100 = 160

Part-b) Inflation using CPI: {(160 - 100)/(100)} * 100 = 60%
Inflation using Deflator: {(150 - 100)/(100)} * 100 = 50%
The deflator reflects less inflation compared to CPI because consumers substituted hamburgers for hot dogs because the hamburgers prices increased less compared to the price of hot dogs did. The deflator takes this substitution into consideration while CPI ignored it.

Answer 2

part a