Current GDP, Real GDP and The Implicit GDP Deflator Index Lecture 9 Dr. Jennifer P. Wissink ©2017 Jennifer P. Wissink, all rights reserved. September 19, 2017 1

The Income Approach to GDP

i>clicker question This economy produced more in year 2 than it did in year 1. A. True False Hard to say A Three-Good Economy PRODUCTION YEAR 1 YEAR 2 Q1 Q2 Good A 6 11 Good B 7 4 Good C 10 12 3

Nominal GDP vs Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. When any variable is measured in current dollars, it is described in nominal terms. Real GDP is GDP measured in reference to some base year so we can control for overall price changes. Simple Old Method (used prior to 1996) Picked a base year as the year chosen to be the reference year. Used the set of prices in the base year to evaluate quantities produced in the base years and in other years. A more complicated procedure is now used to perform these calculations. We will only learn how to perform the old procedure.

Calculating Nominal GDP and Real GDP A Three-Good Economy (1) (2) (3) (4) (5) (6) (7) (8) GDP IN YEAR 1 YEAR 2 IN PRODUCTION PRICE PER UNIT PRICES Q1 Q2 P1 P2 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2 Good A 6 11 $.50 $ .40 Good B 7 4 .30 1.00 Good C 10 12 .70 .90 Total 5

GDP %Changes %change in nominal GDP From our calculations: Nominal GDP in Year 1 = $12.10 Nominal GDP in Year 2 = $19.20 Real GDP in Year 2 (when Base Year = Year 1) = $15.10 Real GDP in Year 1 (when Base Year = Year 2) = $18.40 %change in nominal GDP %change in real GDP (Year 1 is base year) %change in real GDP (Year 2 is base year)

i>clicker questions Assume the base year is 2010. When calculating real GDP for 2017 you use quantities from the base year and prices from 2017. A. True B. False Assume the base year is 2010. The value of real GDP and current GDP will be the same in the base year. A. True B. False Assume the base year is 2010. If the US has been experiencing inflation, real GDP in 2017 will be smaller than nominal GDP in 2017. A. True B. False

The Process of Deflating & the Implicit GDP Deflator Index Deflating: changing a measure from a current or nominal value to a real value by use of a deflator. implies you have a deflator!   To deflate (if you have a deflator): Conveniently: the government reports the following $nominal GDP $real GDP So subbing-in and cross-multiplying we get... And...to make it an index just multiply it by 100! And now it’s called the implicit GDP deflator index!

Nominal GDP, Real GDP & the IGDPDI IGDPDI for 2009 IGDPDI for 2015 Inflation between the base year and 2015 Inflation between 2012 & 2015 IGDPDI for 2015 = IGDPDI for 2012 = Nominal GDP, Real GDP & the IGDPDI year Real GDP, Billions of Chained 2009 Dollars GDP, Billions of Dollars  Implicit GDP deflator Index 2000 12559.7 10148.2   2001 12682.2 10564.6 2002 12908.8 10876.9 2003 13271.1 11332.4 2004 13773.5 12088.6 2005 14234.2 12888.9 2006 14613.8 13684.7 2007 14873.7 14322.9 2008 14830.4 14752.4 2009 14418.7 14414.6 2010 14783.8 14798.5 2011 15020.6 15379.2 2012 15354.6 16027.2 2013 15612.2 16498.1 2014 15982.3 17183.5 2015 16397.2 17803.4 11

Using An Index Like the Implicit GDP Deflator Index In 1975/76 Cornell tuition + fees + room & board cost approximately $5,000 per YEAR! So, based solely on the implicit GDP deflator index, what should Cornell have cost in 2015/2016? 12

ANOTHER Measure of Inflation: The Consumer Price Index The consumer price index (CPI) is a price index computed each month by The Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer. It’s the most popular fixed-weight price index. The CPI market basket shows how a typical consumer divides his or her money among various goods and services.

FIGURE 7.1 The CPI Market Basket

Percentage Change in CPI Percentage Change in CPI TABLE 7.5 The CPI, 1950–2012 Percentage Change in CPI CPI Percentage Change in CPI 1950 1.3 24.1 1971 4.4 40.5 1992 3.0 140.3 1951 7.9 26.0 1972 3.2 41.8 1993 144.5 1952 1.9 26.5 1973 6.2 44.4 1994 2.6 148.2 1953 0.8 26.7 1974 11.0 49.3 1995 2.8 152.4 1954 0.7 26.9 1975 9.1 53.8 1996 156.9 1955 -0.4 26.8 1976 5.8 56.9 1997 2.3 160.5 1956 1.5 27.2 1977 6.5 60.6 1998 1.6 163.0 1957 3.3 28.1 1978 7.6 72.6 1999 2.2 166.6 1958 28.9 1979 11.3 65.2 2000 3.4 172.2 1959 29.1 1980 13.5 82.4 2001 177.1 1960 1.7 29.6 1981 10.3 90.9 2002 179.9 1961 1.0 29.9 1982 96.5 2003 184.0 1962 30.2 1983 99.6 2004 2.7 188.9 1963 30.6 1984 4.3 103.9 2005 195.3 1964 31.0 1985 3.6 107.6 2006 201.6 1965 31.5 1986 109.6 2007 207.3 1966 2.9 32.4 1987 113.6 2008 3.9 215.3 1967 3.1 33.4 1988 4.1 118.3 2009 214.5 1968 4.2 34.8 1989 4.8 124.0 2010 218.1 1969 5.5 36.7 1990 5.4 130.7 2011 224.9 1970 5.7 38.8 1991 136.2 2012 2.1 229.6 Note: 1982-1984=100

Calculating the Consumer Price Index

The IGDPDI vs The CPI

The IGDPDI vs The CPI P Demand A B P2 P1 C E O Q2 Q1 Q

Cool Tool: The BLS “Inflation Calculator” About the CPI inflation calculator: http://www.bls.gov/ The CPI inflation calculator uses the average Consumer Price Index for a given calendar year. This data represents changes in prices of all goods and services purchased for consumption by urban households. This index value has been calculated every year since 1913. For the current year, the latest monthly index value is used.

Why Do We Care So Much About Inflation? Its potential to change the distribution of income. Its special effects on debtors & creditors. The costs of “keeping up” might be self-fulfilling. Resources (time and money) are used up in the mere act of posting and keeping up with price changes and searching for low prices. Increased likelihood that people don’t know (or can’t keep up with) changing relative prices, so they don’t allocate efficiently. Increased uncertainty, pessimism and risk, perhaps making people tentative and investment riskier depresses expenditure on consumption and investment. Real Culprit: asymmetric and unanticipated inflation

And What About Deflation? Its potential to change the distribution of income. Its special effects on debtors & creditors. Can often lead to periods of economic stagnation and high unemployment since people put off buying “stuff” today expecting prices to get lower in the future. Seemed to be a significant part of Japan’s financial crises from circa 1990-2000, the “lost decade”. If it’s hard to cut nominal wages, since everyone moans about that, then real wages will rise during deflations and can lead to unemployment pressure.