The price of imported cotton shirts produced by a Canadian company operating in India increases. By itself, what effect will this change have on the Canadian GDP deflator and CPI?

Question

Quizplus · Accepted Answer

The GDP deflator is a measure of the overall price level in an economy, while the CPI measures the cost of a basket of goods purchased by households. Since the cotton shirts are imported, they are not included in the basket of goods used to calculate the CPI. Therefore, the increase in price of cotton shirts will not affect the CPI. However, the increase in imported input prices will increase the cost of production for the Canadian company operating in India, leading to a decrease in the quantity of shirts produced, and an increase in the price of the shirts that are produced. This increase in price will contribute to inflation in the Indian economy, which will in turn lead to an increase in the price level measured by the Indian GDP deflator. Since the Canadian company is operating in India, its output is included in the Indian GDP, but not directly in the Canadian GDP. However, the increase in the Indian GDP deflator will affect the Canadian economy indirectly, since an increase in the price level in India will increase the price of imports from India, and Canadian consumers will face higher prices for Indian goods. This will cause a slight increase in the Canadian CPI, but this increase will be smaller than the increase in the Indian GDP deflator due to the smaller share of Indian goods in the Canadian consumption basket.

The Price of Imported Cotton Shirts Produced by a Canadian