Econ 102 Winter 2012
Lecture Note 2  Economic Growth
GDP Growth
To study economic growth, we can compare GDP from time period to time period. The simplest measure
would be to look at ∆
GDP
. For example, in 1990, the US GDP was about 5.8 trillion dollars, while today
it is estimated at around $15 trillion.
Are we two and a half times better off today than 21 years ago?
Perhaps, but some might argue that a dollar had different “value” in 1990 than it does today. This is the
reason economists developed the
price index
 to make comparisons between time periods.
The idea is to adjust GDP (or any amount of money) by a factor that represents the quantity of actual
goods that a particular amount of money can buy. Since we are converting units of money to units of actual
goods, we call this a
real
measure. The amount of money is known as the
nominal
measure. For example,
suppose the only final good in the economy is cars, and last year our economy produced 1 car. This year,
our economy also produced 1 car. In
real
terms, GDP stayed the same, but in
nominal
terms, the value of
GDP depends on the price of a car.
Put another way, real GDP is the answer to the question: what would nominal GDP be if we had to
purchase goods at the prices of a different year?
In 1990, a gallon of gasoline cost $1.16.
Using 1990 as
the reference year, Real GDP in 2011 calculated at 1990 prices would be much less, assuming other prices
went up as well. In our simple example above, the price index will simply be the price of 1 car. We then
1
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know that if the price of a car jumps, our nominal GDP will increase even though real GDP stays the same.
Upward changes in a price index is known as
inflation
.
To actually calculate a price index, we could take the same quantities of goods that we bought last year
and calculate the value of those goods using today’s prices.
The price index would then be the ratio of
yesterday’s quantities at today’s prices vs. yesterday’s quantities at yesterday’s prices. This type of price
index is known as a
Laspeyres Index.
Mathematically it looks like:
L
=
∑
i
P
i,t
Q
i,t

1
∑
i
P
i,t

1
Q
i,t

1
where
i
is an index over the number of goods.
Alternatively, we can take today’s quantities and make the same calculation. This is known as a
Paasche
Index
. Mathematically, a Paasche index is calculated:
P
=
∑
i
P
i,t
Q
i,t
∑
i
P
i,t

1
Q
i,t
Note that the values of these indexes depends on the reference time periods.
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 Spring '11
 d
 Inflation, Gdp, Paasche Index

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