Bureau of Economic Analysis data show that with base year 2005? = 100, the GDP p

Question

Bureau of Economic Analysis data show that with base year 2005? = 100, the GDP price index was 109.7 in the second quarter of 2009. In that same? quarter, the PCEPI was 108.8.

Given the further information that the prices of capital goods? (investment) and foreign traded goods? (exports and? imports) increased at a slower pace than the prices of consumption goods and?services, how would you explain the difference in the GDP price index and PCEPI measures of? inflation?

Choose the correct statement.

Explanation / Answer

Solution:-

GDP price index includes the prices of all goods and services that constitute GDP that is consumption, investment, government purchases, and exports.

Personal Consumption Expenditure (PCE) price index includes prices of only those goods and services that are included in consumption component of GDP.

It is given that for the second quarter of 2009, GDP price index was 109.7. Whereas, the PCE price index was 108.8. It was also given that price of capital goods (investment) and foreign traded goods (exports and imports) increased at slower pace than the prices of consumption goods and services.

Even though prices of consumption goods and services has increased at faster pace than the price of investment and foreign traded goods and services, the GDP price index has higher value then the PCE price index. This is because GDP price index also includes the prices of goods and services purchased by the government and prices of these goods and services may have also increased at a rapid pace as well.

So, this fast increase in prices of goods and services purchased by the government in tandem with already fast paced increase in prices of consumption goods and services. This has not only compensated for the slower increase in price of capital goods (investment) and foreign traded goods (exports and imports), but also have resulted in the GDP price index having higher value in comparison to PCE price index. This only includes the prices of consumption goods and services and thus takes into account only the increase in prices of consumption goods and services.

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