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GDP & Changes in Price
Intramural Econ
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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
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• 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
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• 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%
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• 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
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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
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• 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
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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
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• 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
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• 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.