by From Blair Fix, Jonathan Nitzan and Shimshon Bichler But there is a slight conceptual problem. It turns out that the growth of real GDP – ostensibly a single, objective quantity – is highly sensitive to our choice of base year. To illustrate, consider a hypothetical economy that produces only two commodities: 1,000 lb of tomatoes and two laptops. Next, let’s choose 1990 as our base year and assume that tomatoes in that year cost /lb while a laptop costs ,000. In this case, real GDP, denominated in 1990 dollars, would be ,000 (=1,000 + 2 ,000). Now, skip to 1991 and imagine that, in that year, the economy grows by producing one additional laptop. This increase means that real GDP in 1991, denominated in 1990 prices, is ,000 (=1,000 + 3 ,000). Compared to 1990,
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from Blair Fix, Jonathan Nitzan and Shimshon Bichler
But there is a slight conceptual problem. It turns out that the growth of real GDP – ostensibly a single, objective quantity – is highly sensitive to our choice of base year.
To illustrate, consider a hypothetical economy that produces only two commodities: 1,000 lb of tomatoes and two laptops. Next, let’s choose 1990 as our base year and assume that tomatoes in that year cost $2/lb while a laptop costs $2,000. In this case, real GDP, denominated in 1990 dollars, would be $6,000 (=1,000 $2 + 2 $2,000). Now, skip to 1991 and imagine that, in that year, the economy grows by producing one additional laptop. This increase means that real GDP in 1991, denominated in 1990 prices, is $8,000 (=1,000 $2 + 3 $2,000). Compared to 1990, real GDP grew by 33.3 per cent.
So far so good. Now, instead of using 1990 as our base year, let’s use 1991. Production levels remain unchanged: 1,000 tomatoes and 2 laptops in 1990, and 1,000 tomatoes and 3 laptops in 1991. Base-year prices, though, are no longer the same: in 1991, our newly chosen base year, tomato prices double to $4/lb, while laptop prices are halved to $1,000. Under these new conditions, real GDP for 1990, this time denominated in 1991 dollars, is $6,000 (=1,000 $4 + 2 $1,000), while real GDP for 1991, also in 1991 dollars, is $7,000 (=1,000 $4 + 3 $1,000). Unlike before, in this example real growth is only 17 per cent.
And this is the simplest of examples. A slightly more involved example – for instance, one in which the production of laptops is rising and of tomatoes falling – might yield positive real GDP growth with one base year and negative real GDP growth with another.
In other words, real GDP is affected not only by the actual quantities being produced, but also by our choice of base year. And since there are numerous base years to choose from, the same real GDP can end up having many different magnitudes!
http://www.paecon.net/PAEReview/issue87/FixNitzanBichler88.pdf