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Difficulty: MediumEconomic Growth, National Income Accounting, and Development Indicators

Consider the following statements regarding the GDP Deflator and the Consumer Price Index (CPI) in national income accounting:

I. The GDP Deflator reflects the prices of all domestically produced final goods and services, whereas the CPI reflects the prices of a representative basket of goods and services consumed by households.
II. Prices of imported consumer goods directly affect the GDP Deflator but have no impact on the CPI.
III. The weights of items in the GDP Deflator automatically adjust with changes in the composition of national output, whereas the CPI basket weights remain fixed until a base year revision occurs.

Which of the statements given above is/are correct?

  1. I and III onlyAnswer
  2. B
    I and II only
  3. C
    II and III only
  4. D
    I, II, and III

Answer

Statements I and III only are correct.
The correct option identifies that Statements I and III are true while Statement II is false. The GDP Deflator measures price changes across all goods and services produced within national boundaries, and its weights change dynamically as the output composition evolves. In contrast, imported goods are completely excluded from GDP and its deflator, but affect the CPI if consumed by households.

Step-by-Step Solution

1
Analyze Statement I regarding scope of coverage
Statement I is correct. The GDP Deflator encompasses all domestically produced goods and services included in GDP. The CPI covers a specific basket of goods and services purchased by typical urban and rural households.
Scope of coverage distinguishes production-based price deflators from consumption-based price indices.
2
Analyze Statement II regarding treatment of imported goods
Statement II is incorrect. Since GDP measures only domestic production, imported goods are excluded from GDP and thus have no direct effect on the GDP Deflator. Conversely, imported consumer goods (e.g., imported edible oil or electronics) form part of the household consumption basket and affect the CPI.
GDP Deflator measures domestic output prices, while CPI measures consumer expenditure prices regardless of origin.
3
Analyze Statement III regarding weighting mechanism
Statement III is correct. The GDP Deflator uses current-period quantities as weights (Paasche index concept), allowing weights to automatically shift with current production patterns. CPI uses fixed base-year quantity weights until an official rebasing occurs.
Difference in weighting formula between implicit price deflators and fixed-basket consumer indices.

Key Concept

Comparison of GDP Deflator and Consumer Price Index (CPI) in National Income Deflating
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Topics

Economic Growth, National Income Accounting, and Development Indicators