Page 188 - Krugmans Economics for AP Text Book_Neat

goods, the PPI often responds to inflationary or deflationary pressures more quickly
The GDP deflator for a given year is 100
than the CPI. As a result, the PPI is often regarded as an “early warning signal” of
times the ratio of nominal GDP to real GDP in
changes in the inflation rate.
that year.
The other widely used price measure is the GDP deflator; it isn’t exactly a price index,
although it serves the same purpose. Recall how we distinguished between nominal
GDP (GDP in current prices) and real GDP (GDP calculated using the prices of a base
year). The GDP deflator for a given year is equal to 100 times the ratio of nominal
GDP for that year to real GDP for that year expressed in prices of a selected base year.
Since real GDP is currently expressed in 2005 dollars, the GDP deflator for 2005 is
equal to 100. If nominal GDP doubles but real GDP does not change, the GDP deflator
indicates that the aggregate price level doubled.
Perhaps the most important point about the different inflation rates generated by
these three measures of prices is that they usually move closely together (although the
producer price index tends to fluctuate more than either of the other two measures).
Figure 15.3 shows the annual percent changes in the three indexes since 1930. By all
three measures, the U.S. economy experienced deflation during the early years of the
Great Depression, inflation during World War II, accelerating inflation during the
1970s, and a return to relative price stability in the 1990s. Notice, by the way, the large
surge and subsequent drop in producer prices at the very end of the graph; this reflects
a sharp rise in energy and food prices, during the second half of the 2000s, and the sub-
sequent large drop in those prices as energy prices fell during the recession that began
in 2007. And you can see these large changes in energy and food prices reflected most
in the producer price index since they play a much bigger role in the PPI than they do in
either the CPI or the GDP deflator.

figure 15.3

The CPI, the PPI, and the Percent change in
GDP Deflator the CPI, PPI, GDP
deflator
As the figure shows, these three dif-
ferent measures of inflation usually 25% PPI
move closely together. Each reveals a 20
drastic acceleration of inflation during 15
the 1970s and a return to relative 10 CPI
price stability in the 1990s.
5
Source: Bureau of Labor Statistics; Bureau of
Economic Analysis. 0
–5 GDP
–10 deflator
–15
–20
1930 1940 1950 1960 1970 1980 1990 2000 2009
Year

146 section 3 Measurement of Economic Performance