Consider a hypothctical economy that produces only three goo

Consider a hypothctical economy that produces only three goods- A, B and C Intomation on the quantities and prices of each good for two years is given below 2016 Output Price Output Price 2017 Good A5 S10 6 S11 Good B7S159$13 Good C 12 $20 14 $25

Solution

e) In order to find the impact of inflation on household well-being, Consumer price index is a better measure as it studies the variations in the price for a basket of goods sold to the customer and the customers are actual households.

The most comprehensive measure of the overall price level is GDP deflator, as it studies the overall variations in the GDP over a period of time. It takes into consideration the price as well as the quantity purcahsed by the consumer.

f) Results calculated in point d) is typical as it measures the inflation based on Consumer price index and GDP deflator which is a conventional way of measuring inflation. It measures the change in the price paid by the customer for a basket of goods over a period of time.

g) GDP Deflator taken 2017 as the base year

GDP Defaltor = Nominal GDP / Real GDP * 100

Nominal GDP for Year 2016

5*10 + 7*15 + 12*20 = 50 +105 + 240

= 395

Real GDP for Year 2016 taking 2017 as Base Year

5*11 + 7*13 + 12* 25 = 55 + 91 + 300

= 446

So GDP Deflator for Year 2016,

395 / 446 * 100

= 88.57%

GDP Deflator for Year 2017

Nominal GDP = 11*6 + 13*9 + 25*14

= 66 + 117 + 350

= 533

Real GDP for the Year 2017

It will be the same as Nominal GDP as 2017 is taken as base year

So GDP Deflator = 533 / 533 * 100 = 100%

Consumer Price Index is calculated by dividing the change in price with base price and multiplying by 100.

So there would be no change in 2017 , but the CPI of 2016 changes.

h)i) If good C is an investment good, it would not be considered for calculating CPI as it is not consumed and purchased by the consumers.

ii) If good C is a consumption good , but half of its quantity in both years was produced abroad, so half of the quantity would not be a part of GDP as GDP includes the market value of goods produced in the country.