In our previous Economic Insights article, we expanded our understanding of the macro economy with the concept GDP — Gross Domestic Product. And we discovered that the key to assessing changes in our economy is by noticing not just the actual dollar value — but rather the percentage change in our indicator, period over period.
To have a better grasp for evaluating GDP, we need to make another adjustment to our macro measurement, and that is: we must take into account price changes that could affect the dollar value of GDP — and in turn distort the changes in real productivity or real output. So we need to move from the concept “GDP” to “Real GDP”.
As you recall, one way to measure GDP is by summing up, over some period of time, all final output multiplied by each item’s associated price. This is sometimes expressed as:
GDP = Volume x Price
Note that Volume represents both final goods and services.
Of course prices can change, but real output (”O”) may not. If that occurs, the economy really has not grown; “stuff” just costs more. So to correct for this, we want to achieve a GDP measurement in base year prices. That is:
GDP = ∑ BaseYearPricet OutputCurrentYeart
Note that “t = the current year”
How do we actually do this ? In reality, statisticians calculate and estimate nominal (or current) GDP, and then adjust for any price changes by something called the GDP deflator. Assuming prices have generally increased, this measurement will reduce GDP by the percentage change in prices since the base year.
An important question that arises is: what should be the base year on which prices are determined ? In truth, the base year changes from time to time, because the further away we are from the base year — time wise — the less relevant (and the bigger) those price changes become. Also an important factor is the changing composition over time of output or “O”. Prices are associated with the actual goods and services that reflect the productive output of our economy. The further back in time we go, the greater the likelihood that GDP will include more and more goods (and services) that are no longer produced — and hence whose prices would distort the GDP deflator measurement.
In the end, we are interested about the percentage change in real GDP.
This measurement is provided annually (year over year), and as well estimated quarterly (current quarter over previous quarter). So when the news and financial media announces the percentage change in GDP each quarter, what we are really receiving is this:
Percentage change in real GDP, quarter over quarter, at an annual rate.
Furthermore, this estimated percentage change will probably be revised several times before the next quarter calculations are addressed.
A couple of last notes:
- Changes in real GDP, year over year, will be calculated from the total annual data, after the year concludes.
- Once we know real GDP for the year, another measurement of growth in the economy is real GDP per capita: that is $GDP / total population.
In other words, what has the economy achieved, on average, in terms of real GDP per person? This takes into account not only productivity changes, but growth or changes in the population as well.
Next time: What is the role of Inventory in the nation’s productive output ? and if real GDP is increasing (or growing) — why does it not feel like a recovery ?
Tags: concept, current gdp, deflator, dollar value, econometrics, economic indicators, Economics, Economy, financial media, gdp, gdp deflator, Gross domestic product, index numbers, macro economy, macroeconomics, macros, measuring gdp, national accounts, Real gross domestic product, statistics, Value
