Question

A small nation of ten people idolizes the TV show American Idol. All they produce and consume are karaoke machines and CDs, in the following amounts:

A small nation of ten people idolizes the TV show American Idol. All they produce and consume are karaoke machines and CDs, in the following amounts: a. Using a method similar to the consumer price index, compute the percentage change in the overall price level. Use 2009 as the base year, and fix the basket at 1 karaoke machine and 3 CDs. b. Using a method similar to the GDP deflator, compute the percentage change of the overall price level. Also use 2009 as the base year. c. Is the inflation rate in 2010 the same using the two methods? Explain why or why not.

a. Using a method similar to the consumer price index, compute the percentage change in the overall price level. Use 2009 as the base year, and fix the basket at 1 karaoke machine and 3 CDs.

b. Using a method similar to the GDP deflator, compute the percentage change of the overall price level. Also use 2009 as the base year.

c. Is the inflation rate in 2010 the same using the two methods? Explain why or why not.

Answer 1

a)
basket is = 1 karaoke machine and 3 CDs
in 2009, basket price = 1*40+3*10 = $70
in 2010, basket price = 1*60+3*12 = $96
taking 2009 as base year
CPI in 2009 = 70/70 * 100 = 100
CPI in 2010 = 96/70 *100 = 137.14
%age change in price level = 137.14 - 100 = 37.14 % (ANSWER)

b)
GDP deflator = nominal GDP/real GDP * 100
in 2009 : (2009 as base year)

nominal GDP = 10*40+30*10 = $700
real GDP = 10*40+30*10 = $700
GDP deflator = 700/700 *100 = 100

in 2010 :

nominal GDP = 12*60+50*12 = $1320
real GDP = 12*40+50*10 = $980
GDP deflator = 1320/980 *100 = 134.70

%age change in price level based on GDP deflator = 134.70 - 100 = 34.70% (ANSWER)

c)
Inflation is not same in 2010 based on the above two methods. It is 37.14% based on CPI and 34.70% based on GDP deflator. Later considers total products and prices while in CPI method, basket takes predetermined quantities of products per basket and prices. This is the reason of differences from these two methods.