Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory

Question

BlackTom AI · Accepted Answer

When evaluating how a change in the price of a domestically produced good affects macro aggregates, it helps to distinguish between what the GDP deflator measures and what the CPI reflects.
Option 1 says both the GDP deflator and the CPI rise. The GDP deflator tracks price changes for all final goods and services produced domestically, so a higher price for a domestically produced tractor will lift the overall price level in GDP. However, the CPI tracks prices faced by urban consumers for a typical basket of consumer goods and services. A price increase in a capital or producer good (like tractors bought by a firm) does not automatically fold into the consumer basket, so CPI is unlikely to rise from this specific producer price change. Therefore this option overstates the impact on CPI.
Option 2 claims the CPI rises while the GDP deflator does not. As argued, the price increase is in a domestically produced good, which directly affects the price level of GDP and thus the GDP deflator. It is inconsistent to have GDP deflator unchanged while the CPI moves higher due to the same price change in a production input for firms.
Option 3 states the GDP deflator rises and the CPI does not. This aligns with the distinction between the two measures: the GDP deflator responds to changes in prices of all final goods and services produced domestically (including investment goods like tractors), while the CPI focuses on consumer-facing prices and would not necessarily capture a firm-level price change for an industrial good not directly in the consumer basket.
Option 4 suggests neither measure changes. Since the price of a domestically produced tractor increases, at least the GDP deflator should reflect higher prices for final domestically produced goods, so this option is inconsistent with the mechanism of national price level measurement.
In summary, the core idea is that a producer price increase for a domestically manufactured capital good raises the GDP deflator due to its impact on domestic final product prices, but it need not affect the CPI unless that price change spills into consumer goods or the consumer basket. The only option that captures this nuance is the one asserting a rise in the GDP deflator with no corresponding rise in the CPI.

Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factorySingle choice

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