Author Question: Explain how inflation can lead to distortions. What will be an ideal ... (Read 182 times)

B · **on:** Jun 30, 2018

Explain how inflation can lead to distortions.

What will be an ideal response?

Question 2

Will the CPI and GDP deflator always move together? Explain.

What will be an ideal response?

AngeliqueG · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

First, not all prices and wages adjust automatically when inflation occurs. Second, variations in relative prices (which occur when there is not pure inflation) can lead to uncertainty. Inflation can also lead to distortions if the tax system is not adjusted when inflation occurs (e.g. nominal income tax brackets).

Answer to Question 2

No they will not. Some of the goods included in the GDP deflator (some investment goods) are not included in the CPI. Some of the goods included in the CPI (foreign goods) are not included in the GDP deflator.