GDP Deflator vs. CPI Index Two price indices to measure Inflation

GDP Deflator Purpose: Converts Nominal GDP into Real GDP –Nominal-absolute dollars from that year –Real-inflation adjusted dollars from base year Real dollars also called “Constant Dollars “ Only real GDP reflects true quantity of goods/services produced If Real GDP => you are making more goods/services

GDP Deflator vs. CPI Index Both measure inflation but two important differences often cause them to diverge GDP deflator reflects prices of all goods/services produced domestically –broader index than CPI but excludes imports CPI index reflects prices only a market basket of some goods/services bought by consumers –Narrow, consumer index, but includes imports

Two Measures of Inflation Diverge 1965 Percent per Year 15 CPI GDP deflator Oil Spikes raises CPI more than GDP Deflator Conclusion: Oil is a bigger % of the CPI Index than GDP Deflator

Nominal GDP Real GDP X 100 GDP Deflator Index = Base Year will always be 100 GDP Deflator math is similar to CPI Index Real GDP = Nominal GDP X 100 Price Index

Why Inflation is Bad? Difficult for Business to plan for future –price goods/services unclear –Investment becomes difficult Lowers value of U.S. currency Lowers purchasing power (real value of money) Raises long term interest rates –Bond buyers need more nominal interest!

Formula Sheet