On Measuring Aggregate
George H. Blackford © 2010
note provides a brief explanation of some of the more technical aspects of measuring
total output and the average price level. It also examines the relationship
between changes in GDP, productivity, and employment.
the total value of all goods and services produced in the domestic economy.
It is determined by multiplying the quantities of goods and services
produced by their respective prices and summing to get the total value
produced during a specific period of time. Thus, GDP measures the
rate at which the total value of goods and services is produced. Since GDP
is generally measured on an annual basis, it also tells us the total value
of the goods and services that were produced in a given year. In addition,
since the total value of goods and services produced corresponds to the
gross income earned in producing those goods and services, GDP also measures
the rate at which total gross income is earned in the domestic economy and,
when measured on an annual basis, the amount of gross income earned during a
Employment is related to the quantities of goods and services produced, not
their values as such. If we want a measure of total output that is related
to total employment we must adjust the nominal or money value of GDP
for changes in prices. This is normally done by choosing the prices that
exist at a particular point in time (or averages of prices over a particular
period of time) and using those prices to measure the value of the output of
goods and serves produced at other points in time. When the value of GDP is
measured in this way the result is referred to as real GDP or GDP in
constant prices, base year prices, or in base year dollars.
Since real GDP is measured by holding prices constant, changes in real GDP
can occur only if quantities change. Hence, real GDP gives us a way to
measure changes in the sum of all the quantities of output produced.
Nominal GDP and Real GDP measured in 2009 prices are plotted in
Figure 1.4 from 1901 through 2013 using data from the
Historical Statistics of the U.S. (Ca9,
Ca10) for the years 1901 through 1928 and from the
Bureau of Economic Analysis (1.1.5
1.1.6) for the years 1929 through
2010. Nominal GDP and Real GDP in Figure 1.4 are, of
course, the same in 2009 since that is the base year—the year from
which the prices used to measure the value of the output produced in all of
the years were obtained.
Bureau of Economic Analysis. (1.1.5
Historical Statistics of the U.S.
values of Nominal GDP are below those of Real GDP in the years
preceding 2009 in Figure 1.4 because prices in those years were, on
average, lower than they were in 2009. As a result, the value of Nominal
GDP measured in current prices—that is, in prices that existed at
the time—in those years underestimate the differences in the total quantity of
output produced relative to that produced in 2009. Similarly, the values of
Nominal GDP are above Real GDP in the years following 2009
because prices in those years were, on average, higher than they were in 2009.
As a result, the value of Nominal GDP in those years overestimate the
differences in total quantity of output produced relative to that produced in
to year percentage changes in Real GDP (Changes in Output) are
also plotted in Figure 1.4. These rates of change give us a
measure of the rates as which aggregate (i.e., total output) output changes
from year to year.
it should be noted that what we are doing here is adding apples and oranges,
which everybody knows, you can't do. But, of course, you can add apples and
oranges if you have a common unit of measurement, such as ponds or bushels. It
is important to remember, however, that when you do this you don't end up with
either apples or oranges, but, rather, ponds or bushels of fruit, and the sum
tells us nothing at all about the kind of fruit that is included in the
result. In measuring the total output produced within the economy, the common
unit of measurement is the monetary unit, dollars, and the result of summing
the various outputs of goods and services produced as measured in dollars is
the total value of output produce—the real value if prices are held
constant over time or the current or nominal value if the prices
that are current at the time are used. In either case, the sum tells us
nothing at all about the composition of the total or how the composition
changes over time. This apples and oranges problem is intrinsic in all
aggregate measures (measures arrived at by adding to obtain a total) of
disparate economic variables.
difference between the value of nominal GDP and real GDP in each year is
caused by the differences between current year prices and the prices that
existed in the base year (2009 in Figure 1.4), if we divide nominal GDP
by real GDP and multiply by 100 the result is a price index that expresses the
weighted average (weighted by current year quantities produced) of current
year prices to base year prices as a percent of base year prices. This index
is called the
Implicit GDP Deflator. A measure of the rate of inflation that includes
all goods and services that are produced within the economy can be obtained
from this index by calculating its year to year percentage changes.
Implicit GDP Deflator in 2009 prices is plotted from 1900 through 2013 in
Figure 1.5 using the GDP deflator implicit in the
Historical Statistics of the U.S. (Ca10)
for the years 1900 through 1928 and in the series published by the
Bureau of Economic Analysis (1.1.5)
for the years 1929 through 2013. The year to year percentage changes in this
index that give the rate of inflation—that is, the rate of change in the
average price as measured by the index—for each year is also plotted in this
Bureau of Economic Analysis.
Historical Statistics of the U.S.
While the Implicit GDP Deflator provides a measure of
the average price level of all goods and services produced in the economic
Consumer Price Index (CPI) provides a measure of the average price level
of those goods and services that consumers purchase. It is constructed by
surveying consumers to determine how they spend their incomes and creating a
representative market basket that contains goods and services in proportion to
the averages of the goods and services purchased by the consumers surveyed.
Since the quantities in this market basket are fixed, and value of this market
basket changes as prices change over time, if we divide the value of the
market basket in each year by the value in some base year and multiply by 100
the result is an index that expresses the weighted average (weighted by the
quantities in the representative market basket) of current year prices to base
year prices as a percent of base year prices. A measure of the rate of
inflation as it affects consumers can be obtained from this index by
calculating its year to year percentage changes.
Consumer Price Index (which uses the average value of the market basket for
the period from1982 through 1984 for the base year) is plotted from 1913
through 2013 in Figure 1.6. The year to year percentage changes in this
index are also plotted in this figure.
Bureau of Labor Statistics.
Output, Productivity, and Employment
We can use
real GDP as a measure of the output of goods and services produced in the
economy, and by taking the year to year percentage change in this measure we
can calculate the rate at which total output increases or decreases in
each year. These rates are plotted in the bottom graph in Figure 1.4.
They are important because the level of employment over time depends, in part,
on the quantity of output produced. In general, an increase in the quantity of
output produced is associated with an increase in employment and a decrease in
the quantity of output produced is associated with a decrease in employment.
However, the level of employment not only depends on the quantity of output
produced, it also depends on the way in which output is produced.
is that the amounts and kinds of tools and equipment and the ways things are
done tend to increase and improve over time. These increases in the capital
stock and improvements in technology (ways of doing things) tend to increase
the productivity of labor over time which means they increase the
amount of output a given number of workers can produce during a given amount
of time. As a result, in order to maintain a given level of employment, real
GDP must increase over time at the rate labor productivity increases. By the
same token, in order to increase the level of employment, real GDP must
increase at a rate that is greater than the rate at which labor productivity
Bureau of Labor Statistics’ productivity index of output per hour is
plotted in Figure 1.7 from 1965 through 2013 along with the percentage
changes in this index. The percentage changes in this index give the year to
year rates at which labor productivity changed during each year.
Economic Report of the President, 2014.
From 1965 through 2013 this index increased
from 39.4 to 106.2 which implies an effective annual rate of increase equal to
2.1% per year. This means that real GDP had to increase, on average, by 2.1%
per year over the previous 48 years just to maintain the level of employment
that existed in 1965. It also means that during those 48 years it was
necessary for output to grow, on average, by 2.1% plus the rate at which
the labor force grew in order to keep the labor force fully employed.