ECONOMICS 304L
FALL 2007
HANDOUT ON PRICE INDICES
Nominal GDP = GDP in current dollars
Real GDP
= GDP in constant dollars
To calculate REAL GDP, you can use prices in a base year as weights
.
This is a fixed weight procedure because the weights used are the same
for all years and are the prices that prevailed in the base year.
PRODUCTION
PRICE per unit
YEAR 1
YEAR 2
YEAR 1
YEAR 2
Q1
Q2
P1
P2
P1Q1
P1Q2
P2Q1
P2Q2
__________________________________________________________________
Good A
6
11
$.50
$ .40
$3.00
$5.50
$2.40
$4.40
Good B
7
4
.30
1.00
2.10
1.20
7.00
4.00
Good C
10
12
.70
.90
7.00
8.40
9.00
10.80
Total
12.10
15.10
18.40
19.20
Nominal
Nominal
GDP Yr.1
GDP Yr. 2
If you looked only at
NOMINAL GDP, which is what is in fact observed
in the
economy, nominal GDP has risen from $12.10 in Yr. 1 to 19.20 in Yr. 2.
This
is an increase of 58.7 percent.
To find the increase, or % change in GDP between 2 years,
nominal GDP Yr. 2  nominal GDP Yr. 1
nominal GDP Yr. 1
X
100
19.20  12.10
12.10
X
100
.587 X 100 = 58.7%
How can we sort out how much of this change is due to change in output and
how much of this change is due to changes in prices?
If we use yr. 1 as the base year, we use year 1 prices as weights. Then Real GDP in
Yr. 1 is
$12.10 and real GDP in Yr. 2. is 15.10. This is an increase of 24.8%.
1
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View Full DocumentIf we use yr. 2, as the base year, we use year 2 prices as weights. Then real GDP in
Yr. 1 is 18.40 and real GDP in year 2 is 19.20. Real GDP has increased from $18.40
to 19.20. This is an increase of 4.3%.
Note that nominal GDP = real GDP in the chosen base year
.
Note that the growth rate of real GDP is very sensitive to the choice of the base year.
The new BEA procedure takes the geometric average between 24.8 and 4.3. For our
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 Fall '07
 Staff
 Economics, Inflation, Consumer price index

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