Question

Consider an economy that produces and consumes hot dogs and hamburgers. In the following table are data for two different years: Hot Dog and Hamburger Prices Good Quantity in 2010 Price in 2010 Quantity in 2018 Price in 2018 Hot Dogs 200 $2 25 $4 Hamburgers 200 $3 500 $4 Part A: Using 2010 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit price deflator for GDP, and the CPI. Part B: By what percentage did prices rise between 2010 and 2018? Give the answer for each good and also for the two measures of the overall price level. Compare the answers given by the Laspeyres and Paasche price indexes. Explain the difference.

Answer 1

To compute the statistics for each year, we use 2010 as the base year. Nominal GDP is obtained by multiplying the quantity of each good by its respective price. Real GDP is obtained by multiplying the quantity of each good in the base year by the prices in the current year. The implicit price deflator for GDP and the CPI measure changes in prices, and the Laspeyres and Paasche price indexes compare current and base year prices and quantities.

Step-by-step explanation:

To compute the statistics for each year, we need to use 2010 as the base year. Nominal GDP is calculated by multiplying the quantity of each good by its respective price. Real GDP is obtained by multiplying the quantity of each good in the base year by the prices in the current year. The implicit price deflator for GDP is the ratio of nominal GDP to real GDP, multiplied by 100. The Consumer Price Index (CPI) measures the average change in prices of a basket of goods and services.

Between 2010 and 2018, the price of hot dogs increased by 100%, while the price of hamburgers remained the same. The overall price level, as measured by the implicit price deflator for GDP and the CPI, increased by 100% as well. The Laspeyres price index compares the current year's quantities with base year prices, while the Paasche price index compares the current year's prices with base year quantities.

The Laspeyres price index tends to overestimate price changes because it does not account for changes in consumption patterns. On the other hand, the Paasche price index tends to underestimate price changes because it does not take into account changes in producers' response to price changes.