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Deflator and Inflation Flashcards

7 cards from real GDP practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.

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  1. What does it mean when economists say the GDP deflator is a 'Paasche index'?

    Answer: It uses the current year's quantity weights

    A Paasche index uses the current period's quantities as weights, which is why the GDP deflator's basket changes each year to reflect current output.

  2. Which of the following would cause the GDP deflator to rise without causing CPI to rise?

    Answer: Higher prices for domestically produced factory machinery

    Factory machinery is an investment good captured in GDP (and thus the deflator) but not in the CPI's consumer basket.

  3. A central bank uses a 2% inflation target. Which measure would it most commonly use to track this target in the US?

    Answer: PCE deflator

    The Federal Reserve's preferred inflation benchmark is the Personal Consumption Expenditures (PCE) deflator, not the GDP deflator or CPI.

  4. If an economy produces only two goods — apples and cars — and car prices double while apple prices stay flat, the GDP deflator will:

    Answer: Rise by less than double, weighted by the share of each good in GDP

    The deflator is a weighted average; if cars are only part of GDP, their price doubling raises the deflator by a fraction reflecting cars' share of total output.

  5. Nominal GDP in Year 1 is $1,000 and real GDP is $1,000. In Year 2, nominal GDP is $1,100 and real GDP is $1,050. What is the GDP deflator in Year 2?

    Answer: 104.8

    GDP Deflator Year 2 = (Nominal / Real) × 100 = ($1,100 / $1,050) × 100 ≈ 104.8.

  6. Which of the following best explains why the GDP deflator can differ significantly from the CPI in an oil-importing nation when global oil prices spike?

    Answer: Oil imports raise the CPI because households pay more, but the GDP deflator excludes imports

    Imported oil is not domestic production, so it is excluded from the GDP deflator; however, higher oil import prices raise consumer costs captured in the CPI.

  7. An economist observes that real GDP has grown 4% but nominal GDP has grown only 2%. This implies:

    Answer: Deflation of approximately 2%

    If nominal GDP grew less than real GDP, the GDP deflator must have fallen — meaning the overall price level declined, which is deflation.