GDP Deflator and Inflation 3 — Questions and Answers
Question 1: When economists use the GDP deflator to convert nominal figures to real figures, the base year always has a deflator value of:
- 0
- 50
- 100 (Correct answer)
- 1000
Correct answer: 100
By convention, the base year GDP deflator is set to 100, making it the reference point for measuring price-level changes.
Question 2: Country A has nominal GDP of $500 billion and real GDP of $400 billion. What is the GDP deflator?
- 80
- 100
- 125 (Correct answer)
- 500
Correct answer: 125
GDP Deflator = (Nominal GDP / Real GDP) × 100 = ($500B / $400B) × 100 = 125.
Question 3: A sharp increase in the GDP deflator while real GDP is flat implies:
- Economic growth with stable prices
- Inflation with no real output growth (Correct answer)
- Deflation and recession
- Rising imports and falling exports
Correct 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.
Question 4: Which scenario would cause the GDP deflator to rise even if the CPI stays flat?
- A large decrease in the price of imported oil
- A surge in domestic business investment at higher prices (Correct answer)
- A reduction in government spending
- A rise in consumer demand for foreign electronics
Correct 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.
Question 5: Economists often prefer the GDP deflator over the CPI to measure economy-wide inflation because the GDP deflator:
- Is published more frequently
- Automatically reflects the current mix of all domestically produced goods (Correct answer)
- Excludes volatile energy prices
- Only tracks manufacturing sector prices
Correct 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.
Question 6: If the GDP deflator is 110 in Year 1 and 121 in Year 2, what is the inflation rate between the two years?
- 11%
- 10% (Correct answer)
- 21%
- 1%
Correct answer: 10%
Inflation rate = (121 − 110) / 110 × 100 ≈ 10%, meaning prices rose about 10% from Year 1 to Year 2.
Question 7: The implicit price deflator is called 'implicit' because it is:
- Published without government approval
- Derived indirectly by dividing nominal GDP by real GDP (Correct answer)
- Based on consumer surveys rather than official data
- Only calculated every five years
Correct 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.
GDP Deflator and Inflation 3
When economists use the GDP deflator to convert nominal figures to real figures, the base year always has a deflator value of: