VOLUME, PRICE AND VALUE
When you are looking at economic figures you need to be able to tell apart any inflation-related effects from any changes in the real level of economic activity. Economic indicators always measure one of three things:
- Volume, such as numbers of cars
- Price, such as the market price of a car
- Value, such as the market value of cars produced in one month or year
The relationship between these three elements is always as follows:
Volume multiplied by price equals value.
The problem lies in the measurement of these elements. If the volume of cars produced in a year is valued in prices that were ruling in, say, year 2000, the result is an indicator of output in 2000 prices. This data is measured in money units, but it is a volume indicator because it gives us information on changes in volumes, not prices.
This is called 'output in constant prices', 'output in real prices', or 'output in real terms'.
The value of car output measured in actual selling prices is called 'current price' or 'nominal price or terms' data.
Values, current prices, nominal prices and nominal terms include the effects of inflation, but
Volumes, constant prices, real prices and real terms exclude the influence of inflation.
To do the activity download the excel table illustration [Excel file 16K]
The table shows the money value of annual US economic output (GDP) showing changes in output and prices between 1990 and 1999. The following two columns separate out these two factors. Column 2 indicates the volume of output with all goods and services measured in 1996 prices. Column 3 shows the path of inflation over the period studied.
As you can see, the value of output rose in 1990-91 from $5803 billion to $5986, but in terms of 1996 prices, real output fell in the same period from $6708 billion to $6676 billion.
This is because price indicators have been used to convert current to constant prices, or in other words, to deflate. The following rules apply:
- Current prices divided by constant prices (multiplied by 100) equals the price deflator
- Current prices divided by the price deflator (multiplied by 100) equals constant prices
- Constant prices multiplied by the price deflator (divided by 100) equals current prices
Any series of numbers can be converted into index numbers, as you can see from the illustration of indices in the 'digging' section of TimeWeb.
The process is shown below to indicate how Column 4 figures were arrived at:
- A reference base is selected. In this case it is 1996.
- The value in the reference base is divided by 100. (7813/100 = 78.13)
- All numbers in the original series are divided by the result of step 2.
So, for 1991 the index value is 5986/78.13 = 76.62 (rounded up to 77)
Carry out the remaining stages in the process of calculating index numbers for Column 5 constant prices GDP (using exactly the same process as for Column 4). Where there are gaps in the table, you should calculate these and input your answer into the following question:
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