1. Statistics for economic analysis and policy making in Europe Part 9
CONTRACTOR IS ACTING UNDER A FRAMEWORK CONTRACT CONCLUDED WITH THE EUROPEAN COMMISSION

2. National accounts: Volume measurement – Overview
Introductory remarks
Price and volume measurement – comparison over time
Interspatial price and volume indices -measurement in PPS

3. Introductory remarks
In national accounts flows and stocks are expressed in monetary units.
Market prices are used as numeraires to value the extremely diverse transactions recorded in the accounts and to aggregate them.
Intertemporal and interspatial comparisons face the following problem: changes observed in current values result from
changes (differences) in volumes;
changes (differences) in the price levels; and
changes (differences) in relative prices.

4. Introductory remarks
In comparisons of flows and stocks, equal importance has to be given to the accurate measurement of changes in prices and in volumes.
For a number of analyses, such as the assessment of growth, it is essential to ‘isolate’ the change in volume terms from the other effects.
Economic accounts have the advantage of providing a suitable framework for constructing a system of volume and price indices as well as ensuring the consistency of the statistical data.

5. Introductory remarks
It needs to be stressed that such a system of accounts for a reference year at prices of a period other than the reference year provides the description of an economy that has no direct counterpart in observable reality.
A system at constant prices of a base year has to be seen as a model that describes what ‘would have incurred if prices had not changed’.
The same feature is given in the case of interspatial comparisons based on purchasing power parities.

6. Price and volume measurement
For the purpose of intertemporal comparisons the valuation at constant prices means valuing the flows and stocks in an accounting period at the prices of a previous period.
In the ESA 2010 volume is defined using the prices of the previous year.
Change in volume terms is not equal to change in quantities. Change in volume term also reflects change in quality of products and – quite relevant – changes in the product mix of aggregates.  

7. Price and volume measurement
Many flows and stocks, e.g. income, do not have price and quantity dimensions of their own.
However, the purchasing power of such variables can be obtained by deflating the current values with a suitable price index.
Deflated flows and stocks are also described as being in real terms. An example is the real disposable income.

8. Price and volume measurement
The integrated system of price and volume indices
The systematic division of changes in current values into the components 'changes in price' and 'changes in volume' is restricted to flows representing transactions, recorded in the goods and services accounts and in the supporting supply and use framework (ESA ).

9. Price and volume measurement
The integrated system of price and volume indices
The decomposition is carried out both for the data relating to individual industries and products, and for those relating to the total economy.
Flows which are balancing items, such as value added, cannot be directly factored into price and volume components; this can only be done indirectly using the relevant flows of transactions.

10. Price and volume measurement
The integrated system of price and volume indices
The use of the accounting framework imposes a double constraint on the calculation of data:
(a) the balance of the goods and services account must for any sequence of two years be obtained at both current prices and in volume terms;
(b) each flow at the level of the total economy must be equal to the sum of the corresponding flows for the various industries.

11. Price and volume measurement
The integrated system of price and volume indices
The theoretically correct method to calculate value added in volume terms is by ‘double deflation’, i.e. deflating separately the two flows of the production account (output and intermediate consumption) and calculating the balance of those two revalued flows (ESA ).
Output in volume terms can only be calculated on the basis of information on the composition of the output by products.

12. Price and volume measurement

13. Price and volume measurement
Step 1
Calculating
output in
volume terms

14. Price and volume measurement
Step 2
Calculating
intermediate
consumption
in volume terms
value added in
volume terms
as a residiual

15. Price and volume measurement
Step 3
Calculating
the final expenditure
in volume terms

16. Production in volume terms
Constant price calculations are confronted with all the challenges which price statistics faces, such as new products and quality changes.
A special problem area is the one of non-market services. Such services are not sold at a market price: their value at current prices is calculated as the sum of the costs incurred.
In the absence of a unit market price, the unit cost of a non-market service can be considered as equivalent to the price (ESA ).

17. Production in volume terms
The unit cost of a non-market service corresponds to the expenditure which society must incur in order to make use of it.
Thus, where it is possible to define units of quantity for non-market services, it is also possible to apply the general principles for calculating volume and price indices which are outlined above.
It is generally possible to define units of quantity for non-market services which are consumed on an individual basis.

18. Production in volume terms
Given the conceptual difficulties and the absence of consensus on output methods adjusted for quality, such methods are excluded from the central framework in order to preserve the comparability of the results.
According the ESA 2010 in the field of non-market health and education, the estimates of production and of consumption in volume terms have to be calculated on the basis of direct output measures — not adjusted for quality — by weighing the quantities produced by the previous year unit costs of those services.

19. Production in volume terms
In the calculation of the volume, quantities are weighted by prices of the base period, so that the result depends on the price structure.
The volume index is thus defined as a Laspeyres index of quantities.
A price index can be defined by the ratio between the value for the current period and the volume, this index is a Paasche price index.

20. Production in volume terms
The main advantages of using Paasche price indices and Laspeyres volume indices are the interpretation and calculation simplicity and the additivity property in the supply and use balances (ESA ).
For comparisons over longer periods of time, the Laspeyres volume indices and the Paasche price indices are calculated first in relation to the previous year and then the chain indices are determined.

21. Production in volume terms
Because the ESA asks for using the prices of the previous year, only the results for two consecutive years are comparable.
Chained indices present the drawback that they lead to volumes having no additivity so that they cannot be used in the balancing procedures of products based on supply and use tables (ESA ).

22. Production in volume terms
A critical assessment
If one is primarily interested in measuring the volume change from one year to the next much can be said in favour of using the up-to-date weights of the previous period.
In the ESA 2010 the priority of this analytical orientation is given for granted.
Other uses of data in volume terms, such as in long term analyses, all forms of structural decompositions, building econometric models asks for different concepts.

23. Production in volume terms
A critical assessment
Such exercises based on the entire framework should be based on common numeraires for the entire period. For such purposes non-additivity is not just a practical drawback.
Additivity is an essential prerequisite for these types of analyses.
The needs of certain fields of economic research were acknowledged by the ESA 1995, but are not longer mentioned in the ESA 2010.

24. Production in volume terms
“It must be recognized that the lack of additive consistency can be a serious disadvantage for many types of analysis. An aggregate is defined as the sum of its components. Additivity requires this identity to be preserved when the values of both an aggregate and its components in some reference period are extrapolated over time using a set of volume index numbers” (ESA ).
“It is therefore recommended that disaggregated constant price data, i.e. direct valuation of current quantities at base-year prices, are compiled in addition to the chain indices for the main aggregates” (ESA ).

25. Real income
Income flows cannot be decomposed into a price and a volume component.
Therefore price and volume measures cannot be defined in the same way as for the flows and stocks of products.
Income flows can be measured in real terms only if one chooses some selected basket of goods and services on which the income is typically spent and uses the price index for this basket as a deflator of current incomes.

26. Real income
The choice is always arbitrary in the sense that income is seldom spent specifically for purchases during the period in question.
Some of it may be saved for purchases in later periods or, alternatively, the purchases during the period may be partly financed from savings made earlier (ESA ).

27. Real income
GDP at prices of a base year measures the total production (less the intermediate consumption) in volume terms for the total economy.
The total real income of residents is influenced not only by this volume of production but also by the rate at which exports can be traded against imports from the rest of the world (‘Terms of trade effect’).

28. Real income
If the terms of trade improve because export prices rise faster than import prices, fewer exports are needed to pay for a given volume of imports. More products are available domestically.
If the terms of trade deteriorate because import prices rise faster than export prices more exports are needed in exchange for a certain volume of imports. Less products are available domestically.

29. Real income Measurement of the trading gain (ESA 2010 10.46):
X= Exports
M= Imports
P= General price index
Px= Price index exports
Pm= Price index imports

30. Real income
Gross domestic product in volume terms + trading gain or loss from changes in terms of trade Real gross domestic income + real primary incomes receivable from abroad - real primary incomes payable to abroad Real gross national income

31. Real income
Real gross national income + real current transfers receivable from abroad - real current transfers payable to abroad Real gross national disposable income - consumption of fixed capital in volume terms Real net national disposable income

32. Interspatial price and volume indices - Measurement in PPS
The fact that countries have different price levels and currencies poses a challenge to interspatial comparisons of prices and volumes.
Nominal exchange rates are not suitable conversion factors in such comparisons, because they do not adequately reflect price level differences, and because they are not sufficiently stable over time (ESA ).
Instead, Purchasing Power Parities (PPPs) are applied.

33. Interspatial price and volume indices - Measurement in PPS
A PPP is defined as the number of units of country B's currency that is needed in country B in order to purchase the same quantity of goods and services that one unit of country A's currency will purchase in country A.
PPPs can thus be interpreted as the exchange rate of an artificial currency commonly referred to as the Purchasing Power Standard (PPS).
If the expenditures of countries A and B expressed in national currencies are converted into PPS, the resulting figures are expressed in the same price level and the same currency, allowing a meaningful comparison of volumes.

34. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
PPPs for market goods and services are based on international price surveys.
Such price surveys are carried out simultaneously in all participating countries, based on a common product sample.
The sample items are clearly specified in terms of their technical characteristics, as well as other variables that are assumed to influence the price, like installation costs and the terms of sale.

35. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
While priority is given to the comparability of the sample items, this must nevertheless be weighted against their representativity in national markets.
The product sample should ideally be equally representative in all participating countries.
For non-market services, interspatial comparisons face the same problem as intertemporal ones, since no market prices exist in either dimension.

36. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
For this reason, as for intertemporal comparisons, methods are preferred which focus either on the direct measurement of output or on output prices which are subsequently used to deflate expenditure, at least for individual services such as education and health.
In the calculation of PPPs, the same index number formulae are applied as in the calculation of temporal indices. In a bilateral context involving two countries, A and B, either country can be used to establish the weights.

37. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
Viewed from the angle of country A, a Laspeyres-type index with weights from country A can be calculated as well as a Paasche-type index using weights from country B.
However, if the two economies are structurally different, the spread between these two indices may be quite large, and the end result would be heavily influenced by the choice of index.
In binary comparisons, it is thus preferable to apply the average of the two, that is a Fisher index.

38. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
Transitivity implies that the direct PPP between countries A and C is equal to the indirect PPP derived by multiplying the direct PPP between countries A and B (or any other third country) and the direct PPP between countries B and C.
The Fisher PPPs at detailed level are not transitive, but it is possible to derive from them a set of transitive PPPs that resemble the original Fisher indices, using the criterion of least squares for this purpose.

39. Interspatial price and volume indices - Measurement in PPS
Calculation of PPPs (ESA pp.):
Applying the so-called Éltetö-Köves-Szulc (EKS) formula minimises the deviations between the original Fisher indices and produces a complete set of transitive PPPs at detailed level.
The resulting set of transitive PPPs for all countries and all detailed results are aggregated up to the level of total GDP using expenditures from national accounts as weights.

40. Interspatial price and volume indices - Measurement in PPS
The aggregate PPPs at the level of GDP or any other category can be applied in, for instance, the calculation of real expenditures and spatial volume indices.
A PPP divided by the nominal exchange rate between two countries produces a price level index (PLI), that can be used in the analysis of countries' comparative price levels.

41. Thank you for your attention
CONTRACTOR IS ACTING UNDER A FRAMEWORK CONTRACT CONCLUDED WITH THE EUROPEAN COMMISSION