Samsung raises the price of its smartphones manufactured in South Korea and sold in the U.S. (assuming smartphones are included in the CPI basket). What effect does this have on the CPI and the GDP deflator?
Answer
a. CPI increases; GDP deflator is unaffected.
b. CPI decreases; GDP deflator is unaffected.
c. CPI increases; GDP deflator decreases.
d. CPI increases; GDP deflator increases.
The correct answer and explanation is:
The correct answer is: a. CPI increases; GDP deflator is unaffected.
Explanation:
The Consumer Price Index (CPI) measures the average change over time in the prices paid by consumers for a fixed basket of goods and services. In this case, Samsung’s price increase for smartphones manufactured in South Korea and sold in the U.S. would directly affect the CPI because it is part of the basket of goods consumed by consumers in the U.S. Since the price of smartphones rises, this would cause the CPI to increase, reflecting the higher cost of living for U.S. consumers.
On the other hand, the GDP deflator is a measure of the price level of all new, domestically produced, final goods and services in an economy. It reflects the price changes for goods and services produced within the country. Since the price increase is for smartphones imported from South Korea, it does not directly affect the domestic production of goods and services in the U.S. As a result, the GDP deflator remains unaffected by the price increase of imported smartphones.
The distinction between the two indices lies in their scope: the CPI includes imported goods because it tracks prices as they are paid by consumers, regardless of where the goods are produced, while the GDP deflator only includes the prices of goods and services that are produced domestically. Therefore, the price increase of an imported product like Samsung smartphones will impact the CPI but not the GDP deflator.