Question

the gdp deflator in year 2 is 105, using year 1 as the base year. this means that, on average, the cost of goods and services is
○ a. 105% higher in year 1 than in year 2.
○ b. 105% higher in year 2 than in year 1.
○ c. 5% higher in year 1 than in year 2.
○ d. 5% higher in year 2 than in year 1.

Explanation:

The GDP deflator measures the price level of all goods and services produced in an economy. The formula for the GDP deflator is \(GDP\ deflator=\frac{Nominal\ GDP}{Real\ GDP}\times100\). In the base - year, the GDP deflator is 100. If the GDP deflator in year 2 is 105 (with year 1 as the base - year), it means \(\frac{Nominal\ GDP_{year2}}{Real\ GDP_{year2}}\times100 = 105\). Since \(Real\ GDP_{year2}\) is calculated using year 1 (base - year) prices, the increase in the GDP deflator from 100 (base - year) to 105 (year 2) represents a percentage increase in the price level. The percentage change in the price level is \(\frac{105 - 100}{100}\times100\%=5\%\). This implies that, on average, the cost of goods and services (price level) is 5% higher in year 2 than in year 1.

Answer:

D. 5% higher in year 2 than in year 1.