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

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Presentation on theme: "GDP Deflator vs. CPI Index Two price indices to measure Inflation."— Presentation transcript:

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

2 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

3 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

4 Two Measures of Inflation Diverge 1965 Percent per Year 15 CPI GDP deflator 10 5 0 1970197519801985199020001995 2005 Oil Spikes raises CPI more than GDP Deflator Conclusion: Oil is a bigger % of the CPI Index than GDP Deflator

5 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

6 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!

7 Formula Sheet


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