Question

Explain the inflation rate calculated from GDP deflator and the inflation rate calculated from the CPI.

Answer 1

Inflation refers to the increase in the general price level in an economy.

It is calculated using two approaches: CPI and GDP Deflator

Using CPI:

CPI calculates inflation by taking into account only a fixed basket of goods and services produced by an average consumer. Changes in consumer tastes and preferences and new goods are not taken into account here. It compares inflation to a base year.

Inflation = [ (CPI in year 2 – CPI in year 1) / CPI in year 1 ] x 100

Using GDP Deflator:

GDP deflator is an index to compare nominal and real GDP and includes all domestically produced goods and services. Changes in consumer tastes and preferences and new goods are also taken into account here.

Inflation = [ (GDP Deflator in year 2 – GDP Deflator in year 1) / GDP Def. in year 1 ] x 100