GDP & Changes in Price

Intramural Econ

Price Index• Inflation is a rise in the

general price level• It distorts economic statistics• To remove distortions,

economists construct a price index- a statistical series that can be used to measure changes in prices over time

• Can be compiled for specific products, or for a range of time

• 1st, select a base year- year that serves as the basis of comparison for all other years

• The index expresses the price of goods & services in a given year as a percentage of the price of those goods during the base year

• 2nd, select the market basket- representative selection of commonly purchased goods & services

• Then record the price of each item in the market basket

• Finally, total the prices• The total represents the

base year market basket price & has a value of 100%

• To track inflation, we have to track the price of the goods & services in the market basket at regular intervals

• Then compare them to the base year

Major Price Indices

• Constructed for various reasons

• Measures change in price of single items, imported goods, agricultural products, etc

• Base years don’t have to be different

• The index numbers for individual series are only compared w/ numbers of the same series

• Producer Price Index measures price changes paid by domestic producers for their inputs

• Based on a sample of +100,000 commodities

• Reported every month• Broken down into

subcategories ex: farm products, fuels, chemicals, processed foods etc

Real vs Current GDP

• To compare GDP over time, you have to distinguish between changes

• There are changes due to the effects of inflation

• And changes that represent increases in production and income

• When GDP isn’t adjusted to remove the effects of inflation, it is called nominal GDP; or just GDP

• When distortions of inflation have been removed, its called real GDP

• Real GDP reflects what GDP would have been if prices had not changed from what they were in the base year

• Unlike nominal GDP, real GDP shows changes in the price level

• This provides a more accurate figure• Ex. Say in 2004, nominal GDP is $200

billion. However, due to an increase in the level of prices from 2000 (the base year) to 2004, real GDP is actually $170 billion. The lower real GDP reflects the price changes while nominal does not.