Deflator and Inflation Flashcards

When economists use the GDP deflator to convert nominal figures to real figures, the base year always has a deflator value of:

Answer: 100

By convention, the base year GDP deflator is set to 100, making it the reference point for measuring price-level changes.

Country A has nominal GDP of $500 billion and real GDP of $400 billion. What is the GDP deflator?

Answer: 125

GDP Deflator = (Nominal GDP / Real GDP) × 100 = ($500B / $400B) × 100 = 125.

A sharp increase in the GDP deflator while real GDP is flat implies:

Answer: Inflation with no real output growth

If the deflator rises sharply but real GDP doesn't change, prices are increasing without any gain in actual output — that is inflation without growth.

Which scenario would cause the GDP deflator to rise even if the CPI stays flat?

Answer: A surge in domestic business investment at higher prices

Investment goods are in the GDP deflator but not in the CPI, so rising prices for domestically produced capital goods push the deflator up without affecting the CPI.

Economists often prefer the GDP deflator over the CPI to measure economy-wide inflation because the GDP deflator:

Answer: Automatically reflects the current mix of all domestically produced goods

The GDP deflator covers all domestically produced goods and services and updates its basket each period, making it a broader, more flexible economy-wide price measure.

If the GDP deflator is 110 in Year 1 and 121 in Year 2, what is the inflation rate between the two years?

Answer: 10%

Inflation rate = (121 − 110) / 110 × 100 ≈ 10%, meaning prices rose about 10% from Year 1 to Year 2.

The implicit price deflator is called 'implicit' because it is:

Answer: Derived indirectly by dividing nominal GDP by real GDP

The GDP deflator is called implicit because it is not calculated directly but is implied by the ratio of nominal to real GDP.