Constructing Real GDP and the Chain-Type Indexes

• Starting in December 1995, the US Bureau of Economic Analysis (the government office that produces the GDP numbers) start to use the following method to construct the real GDP.

• This method require 5 steps.

• Step 1: Construct the rate of change of real GDP from year t to year t+1 using the prices from year t as the set of common prices;

• Step 2: Constructing the rate of change of real GDP from year t to year t+1 using the prices from year t+1 as the set of common prices;

For example, if t=2000 and t+1=2001, then first construct real GDP for 2000 and 2001 using the 2000 prices as the set of common prices; and compute a first measure of the rate of GDP growth from 2000 to 2001.

Then construct real GDP for 2000 and 2001 using the 2001 prices as the set of common prices; and compute a second measure of the rate of GDP growth from 2000 to 2001.

• Step 3: Constructing the rate of change of real GDP from year t to year t+1 as the average of these two rate of change you get from Step 1 and 2;

• Step 4: Constructing an index for the level of real GDP by linking –or chaining- the constructed rates of changes for each year.

For example, if we choose 2000 to be the base year, then the index is set to 1 in 2000. Given the constructed rate of change from 2000 to 2001 by the BEA is 0.5%, the index for 2001 is (1+0.5%)=1.005.

The index for 2002 is obtained by multiplying the index for 2001by the rate of change from 2001 to 2002 constructed by the BEA, and so on.

In the Economic Report for the President, this index is multiplied by 100 so that it is easier to read, you can consider that to be the percentage.

• Step 5: Finally, multiplying this index by nominal GDP in 2000 to derive real GDP in chained 2000 dollars;

Therefore, for the base year, the real GDP=nominal GDP.

For the 2001 real GDP in chained 2000 dollars: 1.005*Nominal GDP of 2000; and so on,……;

This method is the one used by BEA to construct the real GDP in chained dollars for the USA.