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Economics 1B Lecture 9 S2011

# Economics 1B Lecture 9 S2011 - Economics 1B UC Davis UC D i...

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4/28/2011 1 Economics 1B UC D i UC Davis Professor Siegler Spring 2011 I. Introduction y Suppose \$44 billion of new trucks are produced in the U.S. in 2011, compared to \$40 billion of new trucks in 2010. Can we conclude that the economy produced 10 percent more trucks in 2011 compared to 2010? y We can reach this conclusion only if the average prices of trucks did not change between 2010 and 2011. However, prices always change. y Real GDP measures changes in the quantities of final goods and services, holding prices constant. The question, however, is which prices are held constant? In this case, do we use 2010 or 2011 prices to measure changes in production between 2010 and 2011? 2

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4/28/2011 2 II. The Index Number Problem y The index number problem is that there is no unique way to combine the relative changes in the prices and quantities of various products into (1) a single measure of the relative change of the overall price level and (2) a single measure of the relative change of the overall quantity level. 3 II. The Index Number Problem y Quantity indices (like real GDP) measure the change of aggregate quantities, using price weights. y Price indices (like the GDP price deflator or the Consumer Price Index) measure changes in prices, using quantity weights. y Typically, relative prices and relative quantities i h i di i If i f d move in the opposite direction. If a price of a good gets relatively more expensive, people buy less of it. In this case, the choice of weighting is crucial. 4
4/28/2011 3 III. Chain Weighted Real GDP y Chain weighting was developed by the American economist Irving Fisher a century ago to minimize economist, Irving Fisher, a century ago to minimize the index number problem. Chain weighted indices are also called Fisher indices. y Another advantage of chain weighting is that it avoids the rewrites of economic history that come under the benchmark year (fixed weight) system. y The disadvantage of the chain weighting is that it is more cumbersome to calculate. y The Bureau of Economic Analysis (BEA) moved to chain weighting in 1996. 5 IV. Chain Weighted Real GDP Example y Step 1 : Select a base Year P Q P Q year to serve as a reference value. In the base year, nominal GDP is equal to real GDP. Let 2010 be the base year in this example: 1 1 2 2 2010 \$5 1 \$1 10 2011 \$4 3 \$2 7 2012 \$3 6 \$3 4 6

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4/28/2011 4 IV. Chain Weighted Real GDP Example y Step 2 : Calculate the Y P Q P Q growth in production from 2010 to 2011, using 2010 prices as weights: Year 1 1 2 2 2010 \$5 1 \$1 10 2011 \$4 3 \$2 7 2012 \$3 6 \$3 4 Production in 2011, using 2010 prices = (\$5*3)+(\$1*7) = \$22 7 Production in 2011, using 2010 prices (\$5 3)+(\$1 7) \$22 Production in 2010, using 2010 prices = (\$5*1)+(\$1*10) = \$15 Growth from 2010 to 2011 = (\$22/\$15) = 1.4667 IV. Chain Weighted Real GDP Example y Step 3 : Calculate the Y P Q P
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