Assume an economy with which only broccoli and cauliflower are produced. In year
ID: 1159449 • Letter: A
Question
Assume an economy with which only broccoli and cauliflower are produced. In year 1, 500 million pounds of broccoli are produced and consumed and its price is $0.5 per pound, while 300 million pounds of cauliflower are produced and consumed and its price is $0.8 per pound. In year 2, 400 million pounds of broccoli are produced and consumed and its price is S0.6 per pound, while 350 million pounds of cauliflower are produced and its price is $0.85 per pound. (a) Using year 1 as the base year, calculate the GDP price deflator in year 1 and year 2, and calculate the rate of inflation between years 1 and 2 from the GDP price deflator.Use the regular method not the chain-weighting method in the question(8 points) (b) Using year 1 as the base year, calculate the CPI in years 1 and 2 , and calculate the CPI rate of inflation. Explain any differences in your results between parts(a) and (b).(8 points)Explanation / Answer
1) Nominal GDP (Year-1) = Real GDP (Year-1) = 500 million * $0.50 + 300 million * $0.80 = $490 million.
Nominal GDP (Year-2) = 400 million * $0.60 + 350 million * $0.85 = $537.5 million
Real GDP (Year -2) = 400 million * $0.50 + 350 million * $0.80 = $480 million.
GDP deflator (Year 1) = 100
GDP deflator (Year 2) = ($537.5/$480) * 100 = 111.97.
The % change in the deflator = 11.97%
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2) Year 1’s production basket includes 500 broccoli and 300 cauliflower.
The production basket at year 1 prices = Nominal GDP (Year-1) = $490 million.
The value of the market basket at year 2 prices = 500 million * $0.60 + 300 million * $0.85 = $555 million
CPI (Year 1) = 100
CPI (Year 2) = ($555/$490) * 100 = 113.3.
The % change in the CPI = 13.3%
The CPI reflects higher inflation due to rise in the relative price of broccoli and the basket is fixed in year 1 when relatively higher quantity of broccoli was consumed
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