The correct option is CPI measures production; GDP Deflator measures consumption..
Explanation
The Consumer Price Index (CPI) and the GDP Deflator are two primary indicators used to measure inflation. While both track price changes, they differ significantly in their scope, the basket of goods considered, and the methodology of calculation.Statement-wise Analysis:
- CPI includes imported goods; GDP Deflator does not. is a valid reason for the difference. The GDP Deflator reflects the prices of all goods and services produced domestically. It excludes imported goods. In contrast, the CPI measures the cost of a basket of goods and services bought by consumers, which includes imported items. Therefore, price changes in imported goods affect the CPI but not the GDP Deflator.
- CPI weights are constant; GDP Deflator weights vary. is a valid reason for the difference. The CPI is calculated using a fixed basket of goods and services (Laspeyres index), meaning the weights assigned to different items remain constant over a period. The GDP Deflator allows the basket of goods to change over time as the composition of GDP changes (Paasche index).
- CPI measures production; GDP Deflator measures consumption. is NOT a valid reason (Factually Incorrect). This statement incorrectly reverses the roles of the two indices. The CPI measures consumption (prices paid by consumers), while the GDP Deflator measures production (prices of goods produced domestically). Because the statement is factually wrong regarding what each index measures, it is the correct answer to the question.
- GDP Deflator covers all goods produced; CPI covers a representative basket. is a valid reason for the difference. The GDP Deflator is comprehensive, covering all goods and services produced in the economy. The CPI is based on a representative basket of goods and services that reflects the spending patterns of an average household.
Key Takeaway:
The GDP Deflator is a broader measure of inflation covering all domestic production but excluding imports, whereas the CPI focuses on a fixed basket of consumer goods and services, including imports.