Lesson 3, Topic 2
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Measuring Changes over Time

Abdulaziz July 22, 2020
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  • Nominal GDP
    • A measure of GDP when prices and quantities have not been separated.
  • Real GDP
    • Actual quantity of goods and services.

nominal GDP = price level × real GDP

A Simple Example: Where Real GDP Doesn’t Change

  • To compute GDP across time, we must use one year’s price.
    • Real GDP will be measured in a certain year’s dollars
    • Nominal GDP is measured in current dollars.
  • Consider Apples and Computers:

nominal GDP = (prices of apples × quantity of apples) + (prices of computers × quantity of computers)

  • If the quantity of goods and services produced does not change, but prices do change
    • Nominal GDP will change.
    • Real GDP will not change.

A Second Example: Where Real GDP Changes

  • The magnitude of the change in real GDP will depend on the year’s prices we select to calculate real GDP.

Quantity Indexes: Laspeyres, Paasche, and Chain Weighting

  • Calculating real GDP changes over time:
  • The Laspeyres index
    • Calculates changes in real GDP using the initial prices.
  • The Paasche index
    • Calculates changes in real GDP using the final year prices.
  • Over long-time intervals the two indexes can result in substantial differences.
  • The Fisher index (chain weighting) is the preferred approach to calculating real GDP.
    • Average of the Laspeyres and Paasche index.
    • Preferred because new goods are invented while others become obsolete —making early or recent prices inaccurate.
    • Can be applied on a year-by-year basis if we compute real GDP each year.
Index Numbers
What is an index number? Definition and meaning *

Price Indexes and Inflation

  • Recall the formula for nominal GDP:
  • The GDP deflator is the price level that satisfies the equation.
  • We could compute this formula for two different years to calculate a price change.
  • We could also use the following math trick:
  • The inflation rate is the percentage change in the price level.

Using Chain-Weighted Data

  • Main reason for using chain-weighted data:
  • Prices of computers rapidly changing in 1990s.
  • Main disadvantage:
    • The sum of real C, I, G, NX will not equal real chain-weighted GDP because the prices used in constructing the components are different.
  • General rule to follow:
    • For particular components of GDP, we look at the ratio of nominal variables.
    • When you want real rates of economic growth, use the chain-weighted real measures.