Answer to Question #184564 in Economics of Enterprise for jij

Question

What is the difference between the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) Deflator?

What is the purpose of these? Is the official inflation rate always representative of the actual price changes? What is the reason for this

Answer 1

What is the difference between the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) Deflator?

1. The GDP deflator measures the prices of all goods and services produced, whereas the CPI measures the prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI.
2. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights. In other words, the CPI is computed using a fixed basket of goods, whereas the GDP deflator allows the basket of goods to change over time as the composition of GDP changes.

What is the purpose of these?

The GDP price deflator tracks price increases through all goods and services manufactured in a given economy. Economists will calculate the rate of real economic activity from one year to the next by using the GDP price deflator.

The Consumer Price Index (CPI) calculates the overall rise in prices paid by consumers for a package of goods and services over time, also known as inflation. It aims to estimate an economy's overall price level and, as a result, the buying power of a country's unit of currency.

Is the official inflation rate always representative of the actual price changes? What is the reason for this

Price levels and inflation rates are simplified versions of dynamic processes that can be deceiving at times. A basket of goods/commodities and services is commonly used to gauge market level by looking at how their values adjust over time. This is concerning since there are almost an infinite number of goods and services in an economy, the vast majority of which are never taken into account when determining the price cost. When calculating the CPI, shifts intuition and health care costs, for example, are not taken into account. The rate of publicly announced inflation would be higher if these two were present. These calculations ignore the fact that the economy is competitive, and prices for millions of commodities change on a daily basis. These equations suggest that the economy is either stagnant or tends to a state of equilibrium that does not exist in fact. In certain cases, this kind of data is just economic history, and attempting to use it to forecast the future isn't necessarily straightforward. In general, a higher price level is associated with a higher inflation rate, while a lower price level is associated with a lower inflation rate.