Inflation or Deflation

In our discussion on nominal gross domestic product (GDP) and real GDP, we mention the GDP deflator as a tool that help us measure overall price movements in any economy including our hypothetical economy, Dateland.

Since the GDP deflator is about measuring overall price movements of the goods and services domestically produced, at a first glance, one might think that it might be also a good measure of the overall cost of living of the citizens of the country.

Unfortunately, it is not! There are several reasons that the GDP deflator is not a proper measure of cost of living.

Therefore, economists had to construct a better measure than that of the GDP deflator to measure changes in the cost of living as accurately as possible.

In the early years of the 20 th century (around 1919), they did! It is called consumer price index (CPI). CPI is a metric of the overall cost of the goods and the services purchased by a representative consumer.

Let’s assume that Dateland Statistical Agency (DSA) is responsible for constructing consumer price index.