Module 5

Question 1

why can statistical discrepancy not be a good measure in the true error of computing the GDP

Answer 1

• both the income and expenditure approach could be underestimated (lower than what it actually is)
• then you wouldn’t be able to see it in the discrepancy error

Question 2

what are the 2 main sources of error that you need to be aware of

Answer 2

1. From the difficulty of measuring the value of non-market goods produced
2. Ability of GDP to measure the standard of living

Question 3

what is the error from the difficulty of measuring the value of non-market goods produced

Answer 3

• Non-market goods are those produced in the underground economy and those goods and services that are produced without being sold on a market
• The underground economy includes illegal activities, or legal activities that aren’t reported so taxes can be evaded
• Goods and services that aren’t sold in markets are things like fixing our houses, cooking, etc.
• Statistics Canada can estimate the size of the underground economy, but its difficult tot estimate household production

Question 4

what is the error of the ability of GDP to measure the standard of living

Answer 4

• Ex. even if the quality of education or the health care system is an important factor that contributes to the well-being of an economy, its not taken into account in the GDP
• Same thing for the quality of the environment (air, water, etc.), the level of income inequality, etc.

Question 5

what is the purpose of quantity indexes

Answer 5

to measure the change in the value of a basket of goods at constant prices

Question 6

what does the passche quantity index do

Answer 6

fix the prices to the current period

Question 7

what is the real value/value at constant prices

Answer 7

when the value of a set of goods for different periods is computed using the prices of the same period

Question 8

what does the passche quantity index do

Answer 8

uses the prices of the base period

Question 9

how much is one period for monthly data

Answer 9

1 month

Question 9

why is there an issue with the Laspeyres and Paasche quantity indexes

Answer 9

• they are both based on the value of a basket of goods using prices from a distant period
• Ex. the 1990 Paasche quantity index is the value of the goods purchased in 1980 at the price of 1990
• Since the quality and specificity of goods change rapidly, it makes no sense to value them using prices from distant periods
• Ex. computers in 1990 were very slow compared with the ones we have today
• The price for a personal computer could be over $4k
• Should we use that price to value today’s computer?

Question 9

what is the solution the issue with the Laspeyres and Paasche quantity indexes

Answer 9

• The first solution was to keep changing the base year, but when to change it?
• Now the solution is to never use prices and quantities that are separated by more than 1 period
• 1 period is determined by the frequency of the data

Question 10

how much is one period if the frequency of the data (observation) is 5 years

Answer 10

5 years

Question 10

how much is one period for quarterly data

Answer 10

1 quarter

Question 11

what are price indexes in comparison to quantity indexes

Answer 11

they are like quantity indexes, but the quantities are held fixed instead of prices

Question 11

what does the paasche price index do

Answer 11

hold the current basket of goods fixed

Question 11

what is the fisher quantity index theory

Answer 11

the theory that the ideal index should be between the Paasche and the Laspeyres

Question 11

what does a higher price index mean

Answer 11

it means that a given basket of goods cost more

Question 11

what is the objective of price indexes

Answer 11

to measure the change in value of a fixed basket of goods

Question 12

what is real GDP

Answer 12

• makes production/output/quantity remain constant even when prices are changing
• so an increase in real GDP is an increase in production not price

Question 12

what does the laspeyres price index do

Answer 12

has the basket of goods from the base period that is fixed

Question 13

what does the value of real GDP depend on

Answer 13

• the base year
• ex. the value of 1994 real GDP with the base year of 1992 is 739.5, but the value of the same year with the base year of 1990 is 714

Question 13

how are nominal variables measured

Answer 13

they are measured based on current prices

Question 13

what is nominal GDP measuring

Answer 13

measuring economic activity at current price

Question 13

what happens to nominal GDP when prices increase

Answer 13

nominal GDP will also increase even if production is the same

Question 14

what kind of index is CPI

Answer 14

- laspeyres type of price index - but the price reference period isn't the same as the basket reference period

Question 14

what is a way to obtain real GDP

Answer 14

construct a quantity index and use the index to calculate the real GDP

Question 15

what are the different types of measures of inflation and their purpose

Answer 15

- For measuring the changes in the cost of living, inflation rate is generally based on the CPI - For measuring the changes in the price level of goods produced in the economy, its based on the GDP deflator - Other measures can also serve other purposes - Ex. the Bank of Canada will have their own measure when designing monetary policies

Question 15

how do you interpret index numbers/ real GDP

Answer 15

- can compare the index # to others - ex. comparing the index # of one year to the to the base year = 100 (# - 100) = % change in quantity

Question 16

can you compare 2 real values

Answer 16

only if they are measured at the prices of the same year

Question 17

what is the deflation approach

Answer 17

Consists of transforming nominal values into real values using price indexes

Question 17

how does the deflation approach work

Answer 17

- Each component of the nominal GDP is deflated with the appropriate price index, and you add them up to calculate the real GDP - Ex. the value of durable goods is deflated with a price index constructed from the price of durable goods only - This is done because the prices of each component don’t have the same behaviour

Question 18

what is the inflation rate

Answer 18

the growth rate of the general price level

Question 18

what is the GDP deflator

Answer 18

- an index that measures the overall changes in the price of all goods included in the GDP - Like average movement of all prices

Question 18

what are inflation rates normally

Answer 18

- the annualized growth rates between 2 successive periods - if the data is already annual data, then only need to calculate the growth rates and don't need to annualize it

Question 19

what is the decrease in general price level called

Answer 19

deflation

Question 19

when is the inflation rate is negative

Answer 19

when the price level decreases

Question 19

how do you calculate the inflation rate

Answer 19

- since its a growth rate of the price index, just use the growth rate formula on the price index - the one that is xt - xt-1 / xt-1

Question 19

with the GDP deflator, what can CPI used to do

Answer 19

transform nominal values into real values

Question 19

who is CPI more appropriate for and why

Answer 19

its better for household members because the basket of goods used for the index is what households consume

Question 19

what happens to the real value when it grows at a slower rate than inflation

Answer 19

the real value decreases

Question 19

what does CPI inflation usually do

Answer 19

overestimates the change in cost of living since the items in the basket of goods was determined several periods in the past, and can change over time

Question 19

what happens to the real value when it grows at a faster rate than inflation

Answer 19

the real value increases

Question 19

if the growth rate of nominal wage was higher than inflation, what happens

Answer 19

the variable (ex. wage) was more fully indexed to inflation

Question 19

what happens when the nominal value and inflation grows at the same rate

Answer 19

the variable is indexed to inflation

Question 19

what is it called when welfare/pension benefits grow at the same rate as inflation

Answer 19

its inflation indexed

Question 19

what is inflation-indexed income

Answer 19

a way to preserve the purchasing power of individuals