Ecological EconomicsLecture 10

20th May 2010

Tiago DomingosAssistant Professor

Environment and Energy SectionDepartment of Mechanical Engineering

Collaboration: Rui Pedro Mota

rmota@ist.utl.pt

• 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

Item Quantity

Price

2007

Bread 100 €1.00

Butter 20 €5.00

2008

Bread 160 € 0.50

Butter 22 € 22.50

Nominal GDP in:

- 2007, €200

- 2008, €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% = (250-100)/100

Price Level and CPI

Year Cost of Basket

CPI

2007 €10 100

2008 €25 250

• 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 Deflatoryear x = (Nominal GDPyear x ÷ Real GDPyear x ) * 100.

• Direct calculation of Real GDP = 160 x 1€ + 22 x 5 € = 270 €

• Rate of change in GDP Deflator,

• 113% = (213-100)/100*100

Price Level and GDP deflator

Year Nominal GDP

Real GDP GDP deflator

2007 €200 €200 100

2008 €575 €270 213

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)

Inflation

0

5

10

15

20

25

30

35

1964 1969 1974 1979 1984 1989 1994 1999 2004

% CPI

GDP Deflator

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 Vyear x to prices of a base year Vbase year:

• Vbase year = (Defbase year ÷ Defyear x ) * Vyear x.

• Using the CPI to deflate Vyear x to Vbase year:

• Vbase year = (CPIbase year ÷ CPIyear x ) * Vyear x.

Real vs. Nominal (Portugal)

0

20

40

60

80

100

120

140

160

180

200

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Mill

iard

s eu

ros

Gross domestic product at 2000market prices

Gross domestic product atcurrent market prices

Source: AMECO database