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Western University
Economics 2152A/B
Simona Cociuba

Measurement: Quantity and Price Indices 2220 A: Lecture 4 Simona Cociuba Fall 2012 Assignment 1 is on WebCT Due date is Wednesday, September 26 in class Recap: Nominal and Real GDP Nominal GDP: uses current year prices to value current output. Real GDP: uses base year prices to value current output. old rule or fixed-weight real GDP (fairly simple) I use base year prices instead of current period prices for all years new rule or chained-weight real GDP (a bit more complicated) 1. Get the Fisher index. This means, compute a ratio of real GDP in two consecutive years by taking a geometric average of the Laspeyres and Paasche indices. This ratio is also called a growth factor. 2. Get the level of real GDP. Start with base year: real GDP equals nominal. Then, use the geometric averages from above to infer chained-weight real GDP for other years. s ▯ ▯ ▯ ▯ cwRGDP = cwRGDP ▯ ∑ p ▯1 ▯qt ▯ ∑ pt▯qt t t▯1 ∑ p ▯q ∑ pt▯q | t▯1 t▯{z t▯1 } Fisher Int▯1, t Why Do We Call It the"Chain-Weight" Real GDP? Suppose the base year is period t = 0. cwRGDP t = cwRGDP t▯1 ▯Fisher Index ▯ 1, t = cwRGDP t▯2 ▯Fisher Index ▯ 2,▯1 ▯Fisher Index ▯ 1, t = ... = cwRGDP 0 ▯Fisher Index 0, 1..▯Fisher Index t▯1, t Chained-weight real GDP in year t is linked to chained-weight real GDP in base year 0 through the entire chain of Fisher indices computed for two adjacent years (0,1), (,2 ) (,3 )...( ▯ 1,t) ) level of real GDP in year t is expressed in the prices of base year. Example from Last Class Year 1 Year 2 Year 3 Year 4 Prices good 1 20 21 22 23 good 2 60 59 58 57 Quantities good 1 75 76 77 78 good 2 25 30 35 40 1. Nominal GDP 3,000 3,366 3,724 4,074 2. Fixed-weight Real GDP 3,100 3,412 3,724 4,036 (base=year 3) 3. Chained-weight Real GDP ??? ??? 3,724 ??? (base=year 3) s ▯ ▯ ▯ ▯ ∑ p3▯q4 ∑ p4▯ q4 cwRGDP 4= cwRGDP 3▯ ▯ = ... ∑ p3▯q3 ∑ p4▯ q3 Measurement: Price Indices We talked about how to measure real GDP. Real GDP is an index of the quantity of production in a given year relative to the base year A quantity index=weighted average of quantities of stuff produced. The weights are prices. Next, we’ll talk about price indices. A price index=a weighted average of the prices of goods and services produced in an economy. The weights are quantities. I if all goods and services are i)cgeneral price level I if only goods and services consumed by co)suCPI Measurement: Price Indices Two commonly used prices indices: Implicit GDP price deflator= Nominal GDP ▯100 Real GDP Cost of base year quantity at current prices Current year CPI= Cost of base year quantity at base year prices CPI is a fixed-weight price index (use base year quantity as weight) Assumes that consumers don’t change buying habits So, changes in relative prices over time affect measurement I goods that become more expensive will get a higher weight than they should in the CPI I hence measured inflation will be higher than actual I this upward bias is about 0.5 percentage points for Canada. 2009 CPI Basket in Canada Includes the following categories: Food: weight about 16% Shelter: ~27.5% Household operations and furnishings: ~11.8% Clothing and footware: ~5.6% Transportation: ~19.3% Health and personal care: ~5% Recreation, education and reading: ~11.8% Alcoholic beverages and tobacco: ~3% Weights of b
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