Question

Much of the oil consumed in the United States is imported. When the price of oil rises and the price of other goods do not fall:

a. The GDP deflator rises by more than the consumer price index.
b. Both the GDP deflator and the consumer price index decrease by the same amount.
c. The consumer price index rises by more than does the GDP deflator.
d. Because oil is an import and not produced in the United States, neither the consumer price index nor the GDP are affected.

Answer 1

A rise in oil prices affects the consumer price index (CPI) more than the GDP deflator because the CPI includes imported goods while the GDP deflator reflects only domestically produced goods.

Step-by-step explanation:

When the price of oil rises in the United States and the prices of other goods do not fall, the impact on the consumer price index (CPI) and the GDP deflator can be distinct. The CPI measures the average price change over time of all goods and services purchased by households, while the GDP deflator measures the price change of all domestically produced goods and services within a country.

The foreign price effect indicates that when domestic prices increase relative to other countries, the relative cost of local goods goes up, and exports tend to fall while imports rise. Given that oil is primarily an import and not domestically produced, a rise in oil prices would directly affect the CPI, which includes imported goods. However, the GDP deflator, which only reflects prices of domestically produced goods, would be affected to a lesser extent.

Therefore, the correct answer to the student's question is that c. The consumer price index rises by more than does the GDP deflator.