A number of statistics are computed to measure the price...

A number of statistics are computed to measure the price level, such as the GDP deflator and the CPI. The choice of which of these measures to use depends in many cases on the specific question in which you are interested. For each of the following situations, state whether the CPI or GDP deflator is a more appropriate measure to use and explain why the statistic is preferred. (a) You are interested in looking at the impact of higher prices of imported oil on the overall cost of living. (b) The government is interested in whether increases in defense spending are affecting the price level. (c) An economic consulting firm is investigating the impact on the aggregate price level of more computers and electronic technology used in production.

Transcript

00:02 So both the cpi and the gdp deflator do attempt to measure the price level in the economy, but they do it in different ways, right? the consumer price index is a slightly narrow area index that's designed to reflect the cost of living to consumers.

00:14 The cpi is constructed by building a basket of consumption goods that are commonly consumed by households and tracking the price of how those consumption goods change.

00:24 But that means many things are not in the cpi, right? if the household is not buying bridges or ports or military aircraft or diplomatic services, all these things or factories, all these things which are consumed by the government or by firms, but not by consumers, these are only indirectly tracked in the cpi, right? or not at all.

00:47 The price of a factory will filter through a little bit into the cpi because the price of the factory affects the price of goods and services produced by that factory.

00:57 But things like military expenditure or infrastructure expenditure don't show up in the cpi.

01:03 The gdpetaflator, however, is using all components of the economy.

01:07 It goes back to c plus i plus g, the sort of the entire economy and uses the basket of the entire economy -wide spending as opposed to just a basket of the spending, which faces consumers, right? so, a, oil prices on standard of living, well, answering this question is a job for the cpi, because the cpi is specifically trying to capture the effect on consumers.

01:47 Oil prices affect a lot of things, right? for example, oil prices affect how expensive it is to run the military because the military burns a lot of fuel.

01:56 But the cost of oil prices to the military, while it affects the economy as a whole, certainly doesn't affect the standard of living of the average individual.

02:03 The cpi tracks only what the average individual is consuming, right? so the cpi is the correct answer here, right? b, whether defense spending affects prices...

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