2. What is GDP?
GDP – Gross Domestic Product measures all the
output the country produces in a year.
GDP = C + I + G + (I - X)
It isn’t measured in 255 cows + 25 barrels of oil +
1000 tons of bread etc. It is measured in
currency.
Ex:
European Union 18,140,000 mln USD
USA 17,420,000 mln USD
China 10,360,000 mln USD
Kazakhstan 224,990 mln USD
Uzbekistan 55,000 mln USD
3. There is, however, a problem.
GDP is used to measure the economy, to
understand the economic situation of a country
whether it is growing or decreasing.
For example, let’s say GPD 2013 – 1 mln USD
and GPD 2014 – 3 mln USD, which means that
our economy increased for 2 mln USD. Right?
Well, not exactly.
4. What is the problem?
Or, better say, where is it.
GDP is shown in currency, because it is
measured in prices. GDP = Sum of (Output X
Price).
The price is a subject of change, it can increase
and decrease. Variously for various products.
GDP of a country may rise, but the output might
not rise as much or even decrease, just because
the prices increased which would lead to increase
in GDP.
5. Price Index
To measure the change in real output we need to
measure the change in price level, for that we
invented Price Index.
A price index number records the percentage change in the
price of a selected combination of goods compared to the
base year.
Step 1. To measure the change in price we must keep
the output constant, for that we need THE MARKET
BASKET.
o Market Basket is a collection of goods.
Step 2. Take a year as a base year in relation to
which we will show the change of price.
6. Formula
Price Index Number is measured in Percents.
Ex. This year basket costs 15000 USD, in base
year it costed 10000 USD. Did the price
increase? How much?
7. Answer
PIN = (15000/10000) * 100.
PIN = 150%. The price has increased for 50%.
Above 100%, means that price has increased.
Below 100% means that price has decreased. We
can measure the movement of price for any good.
There is a Consumer Price Index(CPI) which is a
PRICE INDEX for the consumer market basket,
which is a market basket that consists of goods
that every household buys.
Rise of CPI is called inflation, fall is called
deflation.
8. Back to GDP
So GDP, as we said it, is unreliable to measure
economic output, cause the price can change.
Let’s call it money GDP
To solve this problem we need a SPECIAL PRICE
INDEX which we call GDP price deflator.
In case of GDP price deflator market basket from
base year contains all final goods and services
produced in our economy on that base year.
We know the formula by now.
9. Real GDP
Using all we learned we can understand our
economic output and find a Real GDP.
Real GDP is a measure of output
produced by an economy valued in
the prices of the base year.
10. o By this division we are removing the price changes from the
money GDP figure.
o The use of this price index to convert money GDP into
real GDP allows us to compare real GDP and find how much the output
has
actually changed from year to year.
Remember that it is the change in output
that we are seeking.
11. Understanding Real GDP
If real GDP doubles, output has doubled; if real
GDP falls, output has fallen; if real GDP does not
change, then output has remained constant.
Thus price indexes adjust for the changing price
level and allow more meaningful comparisons
between GDP figures.
12. Price adjustment is important
There are also concepts known as money salary
and real salary.
Money salary is the number of dollars in your
paycheck; real salary is the purchasing power of
your salary
in terms of the base-year prices.
It is not just the number of dollars you have that is
relevant, it is how much you can buy with those
dollars.
By converting to real terms, we have eliminated
the impact of inflation on these measures of
spending.
