Question

There are a number of statistics computed to measure the price level, such as the GDP deflator and the CPI. The choice of which of these measures to use depends in many cases on the specific question in which you are interested. For each of the following situations, state whether the CPI or GDP deflator is a more appropriate measure to use and explain why the statistic is preferred.

Answer 1

Question Completion:

a. You are interested in looking at the impact of higher prices of imported oil in the overall cost of living.

b. The government is interested in whether increases in defense spending are affecting the price level.

c. An economic consulting firm is investigating the impact on the aggregate price level of more computers and electronic technology used in production.

Answer:

The GDP Deflator and the CPI

a. The CPI is used here, as its measure is not restricted to domestically produced goods and services.

b. The GDP Deflator is more appropriate here.  Defense spending is not related to consumer goods and services but to government spending, which is a component of the GDP.

c. The GDP Deflator is more appropriate with this investigation.  Computers and electronic technology used in production relate to business Investments, which are a component of the GDP and are not part of consumer goods and services or a component of the CPI.

Explanation:

The GDP deflator is exclusively used to measure the prices of all goods and services produced domestically in an economy and is based on the nominal or real GDP.  On the other hand, the CPI (Consumer Price Index) is used to measure the weighted average prices of a basket of consumer goods and services, whether produced domestically or imported.