Does the CPI Overstate Inflation?

Q1. Consider how each of the following events is likely to affect real GDP. Do you think the
change in real GDP reflects a similar change in economic well-being?

a. A hurricane in Florida forces Disney World to shut down for a month.

 Real GDP: This event is likely to decrease real GDP because economic activity
(tourism, spending at Disney World) will be disrupted.
 Economic well-being: Decreases for the impacted companies and employees.
However, since some of the economic activity lost during the shutdown might be
recovered later, the GDP decline might not accurately reflect the decline in economic
well-being.

b. The discovery of a new, easy-to-grow strain of wheat increases farm harvests.

 Real GDP: Increases due to higher farm output and potentially lower food prices.
 Economic well-being: In particular, if the increased output results in decreased food
prices and increased food security, the GDP growth is probably going to partially
reflect an increase in economic well-being for both farmers and consumers.

c. Increased hostility between unions and management sparks a rash of strikes.

 Real GDP: This event is likely to decrease real GDP as strikes disrupt production and
economic activity.
 Economic well-being: The decline in GDP might indicate a decline in economic
prosperity because of lost output and the social costs of labour unrest, but it might
also result in better working conditions.

d. Firms throughout the economy experience falling demand, causing them to lay off
workers.

 Real GDP: This event is likely to decrease real GDP as decreased demand leads to
reduced production and employment.
 Economic well-being: With a decline in economic activity and possible difficulties for
those who lose their jobs, the GDP decline may very well be a reflection of a decline
in economic well-being.

e. Congress passes new environmental laws that prohibit firms from using production
methods that emit large quantities of pollution.

 Real GDP: May decrease initially due to adjustment costs for firms, but could
increase in the long run due to technological innovation and resource efficiency.
 Economic well-being: May be mixed, with potential benefits for future generations
outweighing short-term costs.
f. More high-school students drop out of school to take jobs mowing lawns.

 Real GDP: May increase in the short run as dropouts provide labor, but may decrease
in the long run due to lower skills and productivity.
 Economic well-being: Long-term earnings potential may decline for dropouts owing
to fewer opportunities and potential earnings. Given that education is an investment
in human capital, the GDP change might not accurately reflect the detrimental
effects on long-term economic well-being.

g. Fathers around the country reduce their workweeks to spend more time with their
children.

 Real GDP: This event is likely to decrease real GDP since people are working fewer
hours which leads to low productivity and lower wages.
 Economic well-being: The potential benefits of greater parental involvement for
families and society are not taken into consideration, so changes in GDP may not
fairly represent shifts in economic well-being.

Q2. Suppose a woman marries her butler. After they are married, her husband continues to
wait on her as before, and she continues to support him as before (but as a husband rather
than as an employee). How does the marriage affect GDP? How should it affect GDP?

The GDP wouldn't be directly impacted by the marriage since no new goods or services
would be created. But the relocation might have unintended consequences as well:

 Since he is no longer paid for his butler services, the husband's GDP contribution may
decrease.
 The wife might spend less on housekeeping services, which would lower the GDP of
the industry.
 Better resource and expense sharing between the couple may result in higher savings
and investment, which over time may help to indirectly increase GDP.
All produced goods and services, including unpaid domestic labour, should ideally be
included in GDP. It is still difficult to determine the exact value of these services, though.

Q3. Was Robert Kennedy right? If so, why do we care about GDP?

Robert Kennedy's argument draws attention to the limitations of GDP as a gauge of

prosperity. GDP calculates the market value of goods and services produced, but it ignores
factors like income inequality, non-market activities, and environmental quality or general
quality of life. It offers a limited economic viewpoint and leaves out more significant facets
of human welfare.

Nonetheless, due to its correlation with numerous facets of material well-being and its
representation of total economic output, GDP continues to be a significant economic
indicator. It facilitates the evaluation of economic conditions by policymakers as well as
cross-national and cross-temporal comparisons of economic performance. The GDP is still a
useful tool for assessing and controlling economic performance, even though it is important
to take other factors and facets of life into account. Alternative metrics, such as the Genuine
Progress Indicator (GPI), have been developed in an effort to overcome some of the
shortcomings of GDP by taking into account elements like income inequality, environmental
sustainability, and the importance of household and volunteer work.