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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

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

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.

Option (c)

The GDP deflator automatically changes the group of goods and services over time...

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