GDP1990 = Output1990 Prices1990 = $5,546.1 billion
GDP1994 = Output1994 Prices1994 = $6,736.9 billion
This appears to be a verysubstantial change in GDP over the course of 4 years. But can
some or all of the change in GDPbe accounted for by a change in prices?
Converting nominal GDP to real GDP using a price index
Price Quantity = Market Value of Output
.50 100 oranges
1.00 300 coconuts
8.00 2,000 pizzas
$16,350Year 1(base year)
Nominal GDP = Real GDP
.50 110 oranges
1.00 330 coconuts
8.00 2,200 pizzas
$17,985 Year 2(quantities increase 10%)
Nominal GDP increases, Real GDP increases
Price Quantity = Market Value of Output
.55 100 oranges
1.10 300 coconuts
8.80 2,000 pizzas
$17,985Year 3(prices increase by 10%)
Nominal GDP increases, Real GDP remains constant
To construct a priceindex, we measure
changes in the priceof a market basket like this
--only with many more items
The representative market basket
In the following illustration, 1987 is our base year--that is, we will express GDP in all other years in 1987 prices. The price index for 1994 is given by:
19871994
19941994
19871994
1994
// PP
OP
PP
GDP
1987
1994
P
P
If we divide GDP measured at current prices by the above price index, we obtain a measure of output in 1994 expressed in 1987 prices
It follows from the above that:
1994
198719941994
19871994
1994
/ P
POP
PP
GDP
P1994 cancels out on the right,so we have:
1987199419871994
1994
/PO
PP
GDP
(1)Year
(2)GDP
(current Prices)
(3)Price Index(1987=100)
(4)=(2) (3)GDP (1987 prices)
1960 $515.3 26.0 $1,970.8
1980 2,708.0 71.7 3,776.3
1990 5,546.1 113.3 4,897.31994 6,736.9 126.1 5,342.3
ALL DATA IN BILLIONS
Implicit Price Deflator for GDP, 1962-97
Source: Economic Report of the President
Year
19971992198719821977197219671962
Imp
licit
GD
P D
eflato
r120
100
80
60
40
20
0
112
100
83
70
47
35
2624
GDP in the U.S., 1962-99
Source: Economic Report of the President
Year
19971992198719821977197219671962
Billion
s
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,0000
Nominal GDP
Real GDP
Chain-type indexes correctfor the “substitution bias”
inherent in “constant dollar”measures of real GDP.
Suppose we use 1992 as our base year to compute real GDP in 1999.
Computer prices have decreased substantially since 1992.
Hence if we measure the value of computers in 1999 at 1992 prices, we will overstate the actual growth of output of computers.
Price Quantity Spending
Apples $1 300 $300
Bread 2 100 200
$500
Year 1
Price Quantity Spending
Apples $2 200 $400
Bread 2.50 200 500
$900
Year 2
Consumers have substituted bread for apples as a result of the relative price change
Calculating the change in real GDP with Year 1 as the base year
2.1500$
600$
500$
)2$200()1$200(
breadapples
Calculating the change in real GDP with Year 2 as the base year
06.1850$
900$
)50.2$100()2$300(
900$
breadapples
If we use Year 1 is our base year, then real GDP growth from
year 1 to year 2 is 20 percent.However, if Year 2 is our baseyear, then the change is only
6 percent.
To compute a chain-typeindex (CTI), we take a geometric
mean of the growth ratesfor the two years.
This is done using the following formula
13.113.11272.1106.12.1 CTI
Chain-type index for GDP, U.S. , 1989-97
Year GDP
1989 81.36
1990 88.27
1991 93.82
1992 100.00 1993 102.94
1994 111.41 1995 123.74 1996 134.03
1997 150.82
To compute the growth rate for, say, 1997:
[150.82/134.03] -1 = 0.125 or 12.5 percent
Source: Bureau of Economic Analysis
•Non-market economic activity
•Secondhand sales
•The underground economy (legal and illegal)
No one knowsjust how big
the underground economy is.
Estimates have gone as high as
13% of “measured”GDP
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