Question

Suppose the table below shows the prices and quantities of the output produced by an economy in two years. If Year 1 is the base year, then the inflation rate in the GDP deflator is 5%.

Good a Good b

Pa Qa Pb. Qb

Year 1 $10.00 100 $4.00 500

Year 2 $9.50. 120 $4.40. 450 

Answer 1

$$Solution.$$

Here, we will have to proof if the statement that the GDP Deflator is 5% is true or false. Therefore,

Inflation rate GDP deflator

$=\frac{GDP\ deflator\ in\ year\ 2-GDP\ deflator\ in\ year\ 1}{GDP\ Deflator\ in\ year\ 1}\\ GDP\ deflator\ in\ year\ 2=\frac{Nominal\ GDP\ in\ year\ 2}{Real\ GDP\ in\ year\ 2}\\ =\frac{120\times9.50+450\times4.40}{120\times10+450\times4}\\ =\frac{3120}{3000}\times100=104\%\\ GDP\ deflator\ in\ year\ 1=\frac{Nominal\ GDP\ in\ year\ 1}{Real\ GDP\ in\ year\ 2}\\ Since, Base\ year=year\ 1\\ Nominal\ GDP=Real\ GDP\in\ year\ 1\\ Therefore, \ GDP\ deflator(year\ 1)=100\%\\ Thus, inflation\ rate\ GDP\ deflator\\ =\frac{104-100}{100}\times100\\ =4\%,$

Therefore the statement is false.