GDP Deflator and Inflation 5

Question 1

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

Accepted Answer

It uses the current year's quantity weights

Answer

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.

Question 2

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

Accepted Answer

Higher prices for domestically produced factory machinery

Answer

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

Question 3

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

Accepted Answer

PCE deflator

Answer

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

Question 4

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

Accepted Answer

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

Answer

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.

Question 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?

Accepted Answer

104.8

Answer

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

GDP - Gross Domestic Product Practice Test

GDP - Gross Domestic Product Practice Test

GDP Deflator and Inflation 5