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Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509

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BuyFindarrow_forward

Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509
Chapter 11, Problem 4CQQ
Textbook Problem
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Because consumers can sometimes substitute cheaper goods for those that have risen in price.

a. the CPI overstates inflation.

b. the CPI understates inflation.

c    the GDP deflator overstates inflation

d. the GDP deflator understates inflation.

To determine
Thesubstitution effect with CPI and GDP deflator.

Explanation of Solution

Option (a)

CPI is computed assuming a fixed basket of goods; it ignores the possibility of consumer substitution. Hence CPI overstates the inflation. So option ‘a’ is correct.

Option (b)

CPI is computed assuming a fixed basket of goods; hence, it overstates substitution and not understates it. Thus, option ‘b’ is incorrect...

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