Differences Between The GDP Deflator and CPI

Differences between the GDP Deflator and CPI
To measure changes in the overall price level in an economy, policy makers and economists monitor a
number of different economic indicators. The two most important ones are the GDP deflator and
the Consumer Price Index (CPI). Even though they usually show similar results, there are two important
differences between the GDP deflator and CPI that can cause them to diverge: (1) they reflect a different
set of prices and (2) they weigh prices differently.
1) They Reflect a Different Set of Prices
The GDP deflator measures the price level of all goods and services that are produced within the
economy (i.e. domestically). Meanwhile, the Consumer Price Index measures the price level of all goods
and services that are bought by consumers within the economy. That means, the GDP deflator does not
include changes in the price of imported goods, while the CPI does not account for changes in the price of
exported goods. In addition to that, the CPI represents a fraction of all domestically produced goods and
services, because it exclusively focuses on consumer goods.
For example, let’s say the price of a Boeing 747 Jumbo Jet increases. Since Boeing is a US company, this
shows up in the US GDP. As a result, the GDP deflator increases. However, a Boeing 747 is certainly not
part of the market basket bought by typical US consumers. Therefore, the price increase will not affect the
CPI. Thus, the increase in the price of a Boeing 747 has an effect on the GDP deflator but no effect on
CPI.
To give another example, assume the price of a Toyota Corolla (i.e. one of the best-selling cars in the US)
increases. This has no effect on US GDP, because Toyota is a Japanese company. However, typical
consumers in the United States buy Toyota Corollas, so the car is part of the typical basket of goods used
to calculate CPI. Hence, the increase in the price of a Toyota Corolla has an effect on CPI but not on the
GDP deflator.
2) They Weigh Prices Differently
The CPI weighs prices against a fixed basket of goods (see also Limitations of CPI) and services, whereas
the GDP deflator examines all currently produced goods and services. As a result, the goods used to
calculate the GDP deflator change dynamically, whereas the market basket used for calculating CPI must
be updated periodically. This can lead to diverging results if the prices of goods represented in both
indicators don’t change proportionally. In other words, when the prices of some goods increase or
decrease more than others, the two indicators may react differently.
For example, let’s look at the prices of Ford trucks. Ford is an American company that sells its cars and
trucks within the United States and abroad. As a matter of fact, Ford ranks in the top 10 for biggest US
export companies (by asset value) and cars sold within the US at the same time. As a result, changes in
the price of a Ford truck show up in both the GDP deflator and CPI. Ford Trucks are produced in the US
and also bought by typical US consumers. However, if Ford Trucks are weighed more heavily in the GDP
deflator than in the CPI market basket, the price increase will have a higher impact on the GDP deflator.
This will cause the two indicators to diverge.
In a Nutshell
To measure the increase in the overall price level in an economy, policy makers and economists usually
monitor both the GDP deflator as well as the Consumer Price Index (CPI). Even though the two
indicators usually show similar results, there are two important differences between the GDP Deflator and
CPI that can cause them to diverge. First, they reflect a different set of prices and second, they weigh
prices differently.
Although at first glance it may seem that CPI and GDP Deflator measure the same thing, there are a few
key differences. The first is that GDP Deflator includes only domestic goods and not anything that is
imported. This is different because the CPI includes anything bought by consumers including foreign
goods. The second difference is that the GDP Deflator is a measure of the prices of all goods and services
while the CPI is a measure of only goods bought by consumers.
CPI vs GDP Deflator
CPI and GDP deflator generally seem to be the same thing but they have some few key differences. Both
are used to determine price inflation and reflect the current economic state of a particular nation.
GDP Deflator takes into account goods that are produced domestically. It does not bother with imported
goods and it reflects the prices of all the commodities, services included. The GDP deflator is calculated
quarterly and it weights may change per calculation.
GDP is an abbreviation of Gross Domestic Product which is the overall value of all final goods and
services made within the borders of a country in specified period. GDP has two types the: Nominal GDP
and the Real GDP. The ratio of the two values is the GDP deflator.
If expressed mathematically,
GDP Deflator = (Nominal GDP/Real GDP) x 100
Essentially, the GDP deflator compares the price level in the current year to level in the base year.
There are so many price indices out there and GDP is unlike some of them that are based on a
predetermined basket of goods and services. In the GDP deflator, the so-called basket in a year is
weighted by the market value of all the consumption of each good therefore it is allowed to change with
people’s investment and expenditure patterns since people do respond to varying prices.
CPI, which is short for Consumer Price Index, indicates the prices of a representative basket of
commodities procured by the consumers. It uses a fixed basket of goods and services and is a widely used
measure of the cost of living faced by consumers of a nation. Like the GDP deflator, it also compares
prices of the current period to a base period.
CPI tends to consider insignificant goods, even the outdated ones that are not really purchased by the
consumers anymore. Nevertheless, they are still considered for pricing in the fixed basket. Consumption
goods are the main priority of the CPI measure. The prices of other items used in production are not
considered as well as the prices of investment goods. Only consumer items are taken into account, the
machines and the industrial equipments that are used to make them are not considered.
As you can see, GDP deflator is not identical with the CPI but provides an alternative to each other as a
measure of inflation. Over long periods of time, both provide similar numbers, but they can diverge in
shorter periods.
Summary:
1. The GDP deflator measures a changing basket of commodities while CPI always indicates the price of
a fixed representative basket.
2. GDP deflator frequently changes weights while CPI is revised very infrequently.
3. CPI will consider imported goods because they are still considered as consumer goods while GDP
deflator will only contain prices of domestic goods.
Read more: Difference Between CPI and GDP Deflator | Difference Between | CPI vs GDP
Deflator http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-gdp-
deflator/#ixzz5gjDn3E00
The first difference is that the GDP deflator measures the prices of all goods and services produced,
whereas the CPI or RPI measures the prices of only the goods and services bought by consumers. Thus,
an increase in the price of goods bought by firms or the government will show up in the GDP deflator but
not in the CPI or RPI.
The second difference is that the GDP deflator includes only those goods produced domestically.
Imported goods are not part of GDP and do not show up in the GDP deflator. For example, an increase in
the price of Toyota made in Japan and sold in the U.K. affects the CPI or RPI, because the Toyota is
bought by consumers in the U.K., but it does not affect the GDP deflator.
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The third difference concerns how the two measures aggregate the many prices in the economy. The CPI
or RPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing
weights. In other words, the CPI or RPI is computed using a fixed basket of goods, whereas the GDP
deflator allows the basket of goods to change over time as the composition of GDP changes. To see how
this works, consider an economy that produces and consumes only apples and oranges.

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Differences between the GDP Deflator and CPI

1) They Reflect a Different Set of Prices

2) They Weigh Prices Differently

CPI vs GDP Deflator

GDP Deflator = (Nominal GDP/Real GDP) x 100

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