Ecological Economics Lecture 10 20th May 2010 Tiago Domingos Assistant Professor Environment and Energy Section Department of Mechanical Engineering Collaboration: Rui Pedro Mota

What part of the change in national accounts aggregates at current prices stems from a change in the quantities (changes in volume) produced and what part stems from a change in prices (inflation)? Temporal Comparison - Real vs Nominal ItemQuantityPrice 2007 Bread100€1.00 Butter20€ Bread160€ 0.50 Butter22€ Nominal GDP in: , € , €575

Consumer Price Index (CPI) –It is based on a fixed (changes every 5 years) basket of goods that are normally an important part of households’ consumption. 1 – Fix the Basket - which prices are most important to the typical consumer? Put weights by surveying consumers and finding the basket of goods and services that the typical consumer buys. 2 – Find the prices for each good and service in the basket. 3 – Compute the basket’s cost (price * quantity) 4 – Choose a base year and compute the CPI Formula 5 – Compute inflation as the rate of change in CPI Price Level and CPI

Macroeconomic measure of consumer price inflation Basket of goods: 5 Breads, 1 Butter Inflation rate = rate of change of price level, 150% = ( )/100 Price Level and CPI YearCost of Basket CPI 2007€ €25250

Movements in the volume of GDP are calculated by recalculating (using multiple price indexes) the values of the various components of GDP at the constant prices either of the previous year or of some fixed base year (SNA93) GDP Deflator year x = (Nominal GDP year x ÷ Real GDP year x ) * 100. Direct calculation of Real GDP = 160 x 1€ + 22 x 5 € = 270 € Rate of change in GDP Deflator, 113% = ( )/100*100 Price Level and GDP deflator YearNominal GDPReal GDPGDP deflator 2007€ €575€270213

GDP deflator vs CPI Both reflect the current level of prices relative to the level of prices in the base year. -Prices of all goods and services produced domestically. - Compares the changes in volume of currently produced goods. -Prices of all goods and services bought by consumers. - Compares a fixed basket of goods and services. GDP Deflator CPI

GDP deflator vs CPI Both reflect the current level of prices relative to the level of prices in the base year. Fixed list and quantities of consumed goods Changes in price CPI Fixed list and prices of produced goods Changes in quantities GDP deflator Intensive – measurable by sampling Extensive – more difficult to measure by sampling

GDP deflator vs CPI (Portugal) Source: AMECO database and UN data Oil Price shock, 1973

Convert Nominal into Real Current price figures measure value of transactions in the prices relating to the period being measured. Constant price series can be used to show how the quantity or volume of goods has changed, and are often referred to as volume measures. Using the GDP deflator (Def) to deflate a variable V in current prices to V year x to prices of a base year V base year : V base year = (Def base year ÷ Def year x ) * V year x. Using the CPI to deflate V year x to V base year : V base year = (CPI base year ÷ CPI year x ) * V year x.

Real vs. Nominal (Portugal) Source: AMECO database