What is the key difference between the Consumer Price Index (CPI) and the GDP deflator?

Question

BlackTom AI · Accepted Answer

To tackle the question, I’ll compare what each index covers and how they’re constructed.
Option a: 'The two indexes measure price changes for different "baskets" of products.' This is correct because the CPI tracks price changes for a fixed basket of goods and services purchased by consumers, while the GDP deflator measures prices for all goods and services produced domestically in the economy. Since the baskets are different, the index values can diverge.
Option b: 'The CPI is broader in coverage than is the GDP deflator.' This is not accurate. The GDP deflator is broader in the sense that it includes all domestically produced goods and services in GDP, not just goods bought by consumers. The CPI focuses on consumer purchases, and can include imports, so it is not broader than the GDP deflator.
Option c: 'The formulas used to construct the indexes bear little resemblance to each other.' In reality, both are price indexes built up from price times quantity measures in a Laspeyres-type framework and share fundamental methodological principles. Saying they bear little resemblance would be misleading.
Option d: 'The GDP deflator includes imports, while the CPI only includes domestically produced goods and services.' This is incorrect. The GDP deflator excludes imports altogether, since GDP sums domestic production, whereas the CPI includes some imported goods as part of the consumer basket. This makes the statement false.

_ECON1220_2024 HW2 (due 10 pm on Wed Mar 5)

What is the key difference between the Consumer Price Index (CPI) and the GDP deflator?

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