Measuring Changes over Time

• 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.

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.