# 52 which indicates that prices rose by 52 percent

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Chapter 8 / Exercise 2
Ethics in Information Technology
Reynolds
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GDP deflator for the year 2010 is 1.52, which indicates that prices rose by 52 percent from what they were in the year 2000. The CPI for the year 2010 is 1.6, which indicates that prices rose by 60 percent from what they were in the year 2000. If prices of all goods rose by, say, 50 percent, then one could say unambiguously that the price level rose by 50 percent. Yet, in our example, relative prices have changed. The price of cars rose by 20 percent; the price of bread rose by 100 percent, making bread relatively more expensive. As the discrepancy between the CPI and the implicit price deflator illustrates, the change in the price level depends on how the goods’ prices are weighted. The CPI weights the price of goods by the quantities purchased in the year 2000. The implicit price deflator weights the price of goods by the quantities purchased in the year 2010. The quantity of bread consumed was higher in 2000 than in 2010, so the CPI places a higher weight on bread. Since the price of bread increased relatively more than the price of cars, the CPI shows a larger increase in the price level. c. There is no clear-cut answer to this question. Ideally, one wants a measure of the price level that accurately captures the cost of living. As a good becomes relatively more expensive, people buy less of it and more of other goods. In this example, consumers bought less bread and more cars. An index with fixed weights, such as the CPI, overestimates the change in the cost of living because it does not take into account that people can substitute less expensive goods for the ones that become more expensive. On the other hand, an index with changing weights, such as the GDP deflator, underestimates the change in the cost of living because it does not take into account that these induced substitutions make people less well off.
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Chapter 8 / Exercise 2
Ethics in Information Technology
Reynolds
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