Constant price GDP

Constant price GDP is a measure of the real output of the economy, which adjusts for inflation and changes in the price level. It is used to measure economic growth rates and economic cycles, and to compare economic output over time in real terms. Constant price GDP is calculated by taking the value of all goods and services produced in a given year, and expressing it in terms of the value of goods and services produced in a base year. This is done by removing the effect of price changes from the output figures of the current year and expressing them as if they had been produced in the base year.

Example of Constant price GDP

Suppose the nominal GDP in 2017 is $10,000 billion and the nominal GDP in 2016 is $9,000 billion. The constant price GDP in 2017 would be calculated as follows:

$GDP_{constant}={\frac {10,000billion}{9,000billion}}\times 100=111.11$

Therefore, the constant price GDP in 2017 is 111.11. This means that the value of goods and services produced in 2017 was 11.11% higher than the value of goods and services produced in 2016, after adjusting for inflation and changes in the price level.

Formula of Constant price GDP

The formula for calculating Constant price GDP is: $GDP_{constant}={\frac {GDP_{current}}{GDP_{base}}}\times 100$

Where GDPcurrent is the nominal Gross Domestic Product in the current year, and GDPbase is the nominal GDP in the base year. The result is expressed as an index with the base year equal to 100.

The formula can be used to calculate the Constant price GDP for any two given years. For example, if the nominal GDP for the current year is 500 and the nominal GDP for the base year is 400, the Constant price GDP would be calculated as follows:

$GDP_{constant}={\frac {500}{400}}\times 100=125$

The result of 125 indicates that the level of economic output in the current year is 25% higher than it was in the base year, when adjusted for inflation.

In conclusion, Constant price GDP is a measure of economic output over time that adjusts for inflation. It is calculated by dividing the nominal GDP of the current year by the nominal GDP of the base year, and expressing the result as an index with the base year equal to 100. This formula can be used to determine the current level of economic output relative to that of the base year.

When to use Constant price GDP

Constant price GDP should be used when comparing economic output across two different periods of time, as it adjusts for the effects of inflation and changes in the price level. This allows for more accurate comparisons of economic output over time, as it removes the effect of price changes and allows for a more accurate comparison of economic performance. Constant price GDP is also used to measure economic growth, as it provides a more accurate measure of output growth than nominal GDP.

Constant price GDP is also useful for comparing economic performance across different countries, as it adjusts for price changes in different countries and allows for a more accurate comparison of economic performance. This is important when comparing different countries, as the price level and inflation rate of each country can differ significantly.

Types of Constant price GDP

There are two main types of constant price GDP: chained-price and fixed-price.

• Chained-price GDP is calculated using the prices of the current year, but with the base year prices used to calculate the weights of each item. This method allows for changes in the composition of the basket of goods and services produced in the current year compared to the base year.
• Fixed-price GDP is calculated using the same weights of the base year, regardless of the current year prices. This method does not account for changes in the composition of the basket of goods and services produced in the current year.

Steps of Constant price GDP

1. Calculate the nominal Gross Domestic Product (GDP) in the current year.
2. Calculate the nominal GDP in the base year.
3. Calculate the constant price GDP by dividing the GDP of the current year by the GDP of the base year and multiplying it by 100.
4. The result is expressed as an index with the base year equal to 100.

Advantages of Constant price GDP

• Constant price GDP eliminates the effect of inflation on the calculation of economic output, which allows more accurate comparison of the output of different years.
• It allows economists to gauge the health of the economy in real terms, as it adjusts for changes in the price level.
• Constant price GDP is an important tool for formulating and assessing economic policies, as it allows economists to measure the effect of these policies in real terms.

Disadvantages of Constant price GDP

• Constant price GDP does not account for changes in the quality of goods and services, which can lead to an underestimation of economic growth.
• It does not capture the effects of changes in the distribution of income.
• Constant price GDP does not necessarily reflect changes in the well-being of the population, as it does not take into account changes in leisure time or environmental quality.

Limitations of Constant price GDP

Constant price GDP has several limitations that should be taken into consideration when interpreting the results:

• It only accounts for differences in price level and does not account for changes in the quality of goods and services produced.
• It assumes that the price structure in the base and current years are the same.
• It does not account for changes in the population or changes in the structure of the economy.
• It does not account for changes in the distribution of income, which can affect the demand for goods and services.

Other approaches related to Constant price GDP

In addition to Constant price GDP, there are several other measures of economic output that adjust for inflation and changes in the price level. These include:

• Gross Domestic Product Deflator (GDP Deflator): This is a measure of the price level of all the goods and services included in the Gross Domestic Product (GDP). It is calculated by taking the ratio of the nominal GDP in the current year to the real GDP in the base year and multiplying it by 100.
• Price Indexes: Price indexes are used to measure changes in the cost of a basket of goods and services over time. Price indexes are calculated by taking the average price of the goods and services in the basket in the current year and dividing it by the average price of the same basket in the base year, and then multiplying it by 100.
• Real GDP: Real GDP is a measure of the value of all the goods and services produced in an economy, adjusted for changes in the price level. It is calculated by taking the nominal GDP of the current year and dividing it by the GDP deflator for the same year, and then multiplying it by 100.

In conclusion, Constant price GDP is a measure of the real output of the economy, which adjusts for inflation and changes in the price level. It is used to measure economic growth rates and economic cycles, and to compare economic output over time in real terms. Other measures of economic output that adjust for inflation and changes in the price level include the Gross Domestic Product Deflator, Price Indexes, and Real GDP.

Constant price GDP — recommended articles

GDP deflator — Net domestic product — National income measures — Percentage point — Okuns law — Wholesale price index — Total factor productivity — Effective exchange rate — Real income

References

• Herwartz, H., & Schlüter, S. (2017). On the predictive information of futures' prices: A wavelet-based assessment. Journal of Forecasting, 36(4), 345-356.
• Heaney, R., & Pattenden, K. (2005). Change in unconditional foreign exchange rate volatility: an analysis of the GBP and USD price of the Euro from 2002 to 2003. Applied Economics Letters, 12(15), 929-932.
• Heaney, R., & Pattenden, K. Change in Unconditional Exchange Rate Volatility: GBP and USD Price of the Euro 2002-2003.