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Unformatted text preview: II3/1Review:3. Does G.D.P. measure how well off we are?“sort of”  it measures our access to goods and services thatare sold through the marketBUT  it does not account for harm done during production it does not account for depletion of scarce resources it does not include illegal activity it does not include household production it does not include volunteer work4. How to correct for prices?Suppose we know that I spent $6000 in 1973, and $50,000 last year.When was I better off? And by how much?The problem is that $6000 represents the value of the bundle of goods and services that I bought in 1973, at 1973 prices, i.e. P1973t B1973and the $50,000 represents the value of the bundle of goods and services that I bought in 2006, at 2006 prices, i.e. P2006t B2006What we really want to do is value the two bundles at the same prices and see which one is more valuableII  3/2Three ways we can do that:1. Value both bundles in 1973 pricesSo: compare P1973t B1973and P1973t B2006the 1973 bundle is already valued that way,$6000 or P1973t B1973the 2006 bundle is P2006t B2006and we want to convert it into P1973t B2006We could do this using BAD LINEAR ALGEBRAby multiplying by P1973/P2006so (P2006t B2006)(P1973/P2006) = P1973t B2006It looks like we can cancel P2006 and “sort of”get P1973t B2006which would be the 2006 bundlevalued at 1973 prices.Unfortunately, linear algebra does NOT (!!!!!) work this way. We can’t take the ratio of two vectors P1973/P2006and vectors don’t cancel this way.BUT if think about P1973/P2006as the ratio of the price indexes, it actually sort of worksSo what we do is compare P1973t B1973with P2006t B2006X ratio of (price indexes in 1973 and 2006)II – 3/3The second way to make the comparison is2. Value both bundles in 2006 pricesthe 2006 bundle is already valued that way,$50,000 or P2006t B2006the 1973 bundle can be converted by multiplying by Price index in 2006/Price index in 1973so $6000(P2006/P1973) or (P1973t B1973)(P2006/P1973)THIS IS BAD LINEAR ALGEBRABUT IT HELPS US REMEMBER3. Value both bundles in some other year’s prices  say 1988 pricesthe 1973 bundle can be converted by multiplying byPrice index in 1988/Price index in 1973so $6000(P1988/P1973) or (P1973t B1973)(P1988/P1973)the 2006 bundle can be converted by multiplying byPrice index in 1988/Price index in 2006so $50,000(P1988/P2006)or (P2006t B2006)(P1988/P2006)II3/4Now: Correcting for prices:GDP = $200 in year 1= $240 in year 2We say that “nominal” GDP, or “current dollar” GDP has risen by 20%Now suppose price index (GDP deflator)= 125 in year 1= 140 in year 2(100 in year 0)We want some measure of GDP in unchanged prices:To correct to year 0 prices year 1 GDP = $200 x 100/125 = $160...
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This note was uploaded on 06/13/2011 for the course ECON A06 taught by Professor Mk during the Spring '11 term at University of Toronto.
 Spring '11
 MK

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