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nat-acc

# nat-acc - National Income Accounting 1 September 2011 1...

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National Income Accounting 1 September 2011 1 Reading Chapter 2 of Abel/Bernanke/Croushore 2 Gross Domestic Product Gross Domestic Product (GDP) — the market values of the goods and services pro- duced in the economy over a given period of time, usually a year or a quarter of a year. Shortcomings of measured GDP as an indicator of the level of economic activities: 1. measures production, not welfare 2. omits the value of housework, activities in the underground economy, value of leisure time, etc 3. neglects the damages to the environment 4. neglects the distribution of income 5. could involve large measurement errors in gauging the value of production in the public sector When the market prices used in computing GDP are prices in the same year — Nominal GDP . Ex: GDP t = p 1 ,t × q 1 ,t + p 2 ,t × q 2 ,t + ... GDP t +1 = p 1 ,t +1 × q 1 ,t +1 + p 2 ,t +1 × q 2 ,t +1 + ... Comparing nominal GDP across years may mislead because the comparison confounds changes in physical quantities and prices. 1

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Figure 1: Gross Domestic Product in Hong Kong Real GDP is nominal GDP but holding constant the general price level . To hold constant the general price level, choose a base year (such as 2006) and calculate market values by using prices in the base year — GDP in constant dollars (as opposed to GDP in current dollars — a term that was used interachangably with nominal GDP in the past), real GDP t +1 = p 1 ,t × q 1 ,t +1 + p 2 ,t × q 2 ,t +1 + ... GDP is the sum of quantities of a multitude of goods, where the weights in computing the sum are the relative prices of the goods: GDP t = p 1 ,t × q 1 ,t + p 2 ,t × q 2 ,t + ... Weights in constant—dollars GDP are weights that were relevant in the base year: real GDP t +1 = p 1 ,t × q 1 ,t +1 + p 2 ,t × q 2 ,t +1 + ... ; such weights become less and less relevant over time due to changes in relative prices. Consider the following example. 2
Price Quantity Year 0 Good 1 10 80 Good 2 7 20 Year 10 Good 1 15 112 Good 2 7.7 40 In year 0, the relative price of good 2 is 7/10. In year 10, it falls to 7.7/15. The contribution to GDP of a unit of good 2 (relative to good 1) is smaller in year 10 than in year 0. In computing constant-dollar GDP in year 10, with year 0 as the base year, we presume the relative contribution of a unit of good 2 remains equal to 7/10. The true relative contribution is only 7.7/15. Between year 0 and year 10, the growth in the quantity of good 2 is 100%. The growth in the quantity of good 1 is 40%. An overestimate of the growth of GDP results. By sticking with weights implied by the relative prices prevailing at year 0, we put more weights on a unit of good 2 than we should in calculating year 10 GDP. Solution: change the base year often. Better still, as often as possible. The resulting procedure is Chain-weighted real GDP . We start with 2006. Then real GDP 2007 = 2006 nominal GDP × 2007 GDP at ave price btw 06 & 07 2006 GDP at ave price btw 06 & 07 real GDP 2008 = 2006 nominal GDP × 2007 GDP at ave price btw 06 & 07 2006 GDP at ave price btw 06 & 07 × 2008 GDP at ave price btw 07 and 08 2007 GDP at ave price btw 07 and 08

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