Question

1- List three things that are not included when calculating Gross Domestic Product, and may result in overstating or understating GDP.

1a- What is the most widely reported measure of inflation? (2 points)

1b-Define Consumer Price Index. (5 points)

Answer 1

1. Three things not included in GDP:

i) Black market activity e.g. narcotics transactions, human trafficking
^ If such activity goes unreported then income "leaks out" of the Income-Output circular flow of money as measured by the National Income Accounts; thus GDP calculated on the basis of income would be a underestimation

ii) Informal sector e.g. babysitters, street vendors, housemaids, house cleaners, gardeners. For a number of reasons (poor access to banking facilities, distrust of the system, elligibility for welfare benefits) their pay goes wholly unreported.

iii) Resale of items purchased previously e.g. real estate.

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2. The most widely reported measure of inflation is the Consumer Price Index (CPI), followed by the Wholesale Price Index.

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3. CPI measures the change in price of the basket of products an average family buys. It is a way to see if 100 dollars that customers had in 1990 (for example) can still buy them the same amount of products in 2020 (or any year after 1990);
if not, then where the change(s) occurred and by how much.

First economists determine the basket of goods an average family buys. These products are then sorted into sub-categories, and each category is weighted. The higher the weight, the more important those particular products are for day to day sustenance
e.g. gas and groceries tend to be weighted higher compared to products in the entertainment category.

Once this is set up, agencies keep track of individual prices to see if they are going up or down, and by how much. Then these prices are weighted (weights of corresponding categories or items) to calculate the average price level across the economy. This average price level for an year can be compared to previous years, yielding the necessary insight about movement in the aggregate price level over the years.