3.3.4: Comparing the CPI and GDP Deflator

The consumer price index is accurate in measuring changes in the quality of products. Select one: True False

False Since the CPI assumes that households purchase exactly the same "basket" of goods and services from year to year, it does not take into account improvements in the quality of products.

If an increase in the price of gasoline causes people to ride bicycles more than before, the consumer price index will underestimate the cost of living. Select one: True False

False The CPI assumes that people buy the same "basket" of goods and services. If people stop purchasing a particular good and replace it with a less expensive alternative, the CPI will then be overestimating the actual cost of living.

The consumer price index is the index that government accountants use to adjust nominal GDP to get real GDP. Select one: True False

False The consumer price index measures only consumer goods. It does not contain every good or service that is included in GDP. The GDP deflator is more inclusive in that it contains all components of GDP. Therefore to adjust nominal GDP to get real GDP, government accountants use the GDP deflator.

The consumer price index fails to take into account the fact that consumers substitute less expensive goods for those goods whose prices have risen. Select one: True Correct False

True Since the CPI assumes that households are purchasing the same "basket" of goods and services from year to year, it does not take into account substitutions of one purchase for another.

An increase in the price of construction equipment will have a greater influence on the GDP deflator than it would on the consumer price index. Select one: True Correct False

True The CPI only takes into account the "basket" of goods and services purchased by a typical household, which would not usually include construction equipment. The GDP deflator, on the other hand, looks at a much wider array of goods and services in the marketplace, and thus would be influenced by a rise in the price of construction equipment.

Which of the following statements about the CPI is not correct? Select one: a. Quality changes are reflected in the CPI. Correct b. The CPI's basket of goods does not change from year to year. c. The CPI has a base year from which changes in price are compared. d. The CPI uses a base year's basket of goods and the current year's prices to calculate inflation.

a. Since the CPI assumes the exact same "basket" of goods and services are purchased from one year to the next, improvements in the quality of goods (for example, those resulting from technological advances) are not reflected in the CPI.

If the price of bread rises and consumers decide to purchase less bread and more bagels, the CPI is experiencing Select one: a. a substitution bias. b. a quality improvement bias. c. a new goods bias. d. a measurement bias.

a. The CPI assumes that consumers will be purchasing the same "basket" of goods and services from year to year, ignoring the fact that when the price of a good rises, sometimes consumers substitute different goods; in this case, bagels for bread. This flaw in the CPI is called substitution bias.

Which of the following would cause both the U.S. consumer price index and the U.S. GDP deflator to increase? Select one: a. An increase in the price of Sony TVs produced in Japan and sold in the U.S. b. An increase in the price of Ford pickup trucks produced in the U.S. and sold in the U.S. c. An increase in the price of agricultural equipment made in the U.S. and sold in the U.S. d. An increase in the price of tanks for the U.S. military by General Motors

b. An increase in the price of Sony TVs produced in Japan The CPI contains only items that a typical consumer would purchase. The definition excludes military and agricultural equipment. A foreign-produced good could be in the CPI but would not be included in the U.S. GDP deflator. Correct

Which of the following statements about the CPI and the GDP deflator is not true? Select one: a. The CPI tends to overstate the rate of inflation. b. The GDP deflator is a better measure of overall price changes. c. The GDP deflator is subject to substitution bias. Correct d. The CPI is subject to substitution bias.

c. Because the GDP deflator looks at a broader array of goods and services than typical consumer household purchases, and because it does not assume that the same "basket" of goods and services is purchased from one year to the next, the GDP deflator is not subject to substitution bias.

Empirical evidence has shown that the U.S. consumer price index and GDP deflator generally move in the same direction. Select one: True False

True While the CPI may overstate the rate of inflation compared to the GDP deflator, the two measures generally agree upon the direction of that inflation.

Unlike the consumer price index, the GDP deflator can be used to measure Select one: a. the increase in the cost of living for a typical US household. b. the increase in nominal GDP that is attributable to price increases rather than production increases. Correct c. the increase in the federal government budget that is a attributable to price increases rather than increased real expenditures. d. the increase in real GDP that is attributable to price increases rather than production increases.

b. The GDP deflator is the ratio of nominal GDP (current production at current prices) to real GDP (current production at fixed base year prices), multiplied by 100. The CPI uses fixed quantities from a base year to weight prices.

In which of the following sectors would a 15% increase in price most affect the CPI? Select one: a. Transportation b. Food c. Housing d. All the above have the same impact because the sectors are equally weighted.

c. The Bureau of Labor Statistics weights household expenditures on housing more heavily than any other sector of the "market basket" of typical household purchases.