# How to compute real gdp

### Why Not the Latest Observations?

We use annual data for our computations, therefore, it is necessary to have an annual observation for both the initial year and the desired year. For the indices based on GDP, it is only after the year is over that GDP can be measured. For price indices, the annual observations are usually the average of monthly observations. It would not be valid to compare a monthly observation in the current year with an annual observation in an earlier year.

Determining the relative value of an amount of money in one year compared to another is more complicated than it seems at first. There is no single "correct" measure, and economic historians use one or more different indicators depending on the context of the question.

Most indices are measured as the price of a "bundle" of goods and services that a representative group buys or earns. Over time the bundle changes; for example, carriages are replaced with automobiles, and new goods and services are created such as cellular phones and heart transplants.

These considerations do not stop the fascination with these comparisons or even the necessity for them. For example, such comparisons may be critical to determine appropriate levels of compensation in a legal case that has been deferred. The context of the question, however, may lead to a preferable measure other than real price as measured by the Consumer Price Index (CPI), which is used far too often without thought to its consequences.

### Here Are Some Examples

How does George Washington's salary compare today?

George Washington was paid a salary of \$25,000 a year from 1789 to 1797 as the first president of the United States. The current salary of the president is now \$400,000, to go with a \$50,000 expense account, a generous pension and several other benefits. Has the remuneration improved?

Making a comparison using the CPI for 1790 shows that \$25,000 corresponds to over \$647,000 today, so current presidents have an equal command over consumer goods as the Father of the Country.

When comparing Washington's salary to an unskilled worker, or the measure of average income, GDP per capita, then the comparable numbers are \$12 to \$27 million. Granted that would not put him in the ranks of the top 25 executives today that make over \$200 million. It would, however, be many times more than any elected official in this country is paid today. Finally, to show the "economic power" of his wage, we see that his salary as a share of GDP would rank him equivalent to \$2.1 billion.

The Erie Canal

The Erie Canal was built between 1817 and 1825 for a price of \$7 million. This waterway is regarded as one of the most important investments in the nineteenth century as it opened the Midwest to trade and migration. How does its cost compare to what its cost would be today?

Using the GDP deflator for 1825 shows that it would be \$170 million, not more than the cost today of a few miles of Interstate highway. Using the unskilled wage measure the cost is \$1.74 billion. From a historical point of view, this may be the best measure as most of the cost of building the canal was probably unskilled labor. Using the manufacturing workers index gives us a much higher cost of \$3.8 billion.

Because of the volatility of prices in that period, if we had chosen 1817 instead of 1825, the GDP deflator computations would have been about 25% less and the other measures are different by similar magnitudes as well. This is a good example of how "approximate" these comparisons are.

Slavery in the United States

In that year, there were an estimated four million slaves living in the South and it is estimated that their aggregate market value was over \$3 billion then. That corresponds to \$10 trillion today (as a share of GDP).

The \$6.7 billion does not take into account that the war disrupted the economy and had an impact of lower production into the future. Some economic historians have estimated this additional, or indirect cost, to be another \$7.3 billion measured on 1860 dollars. This means the cost of the war (as a share of the output of the economy) was nearly \$52 trillion as measured in current dollars.

The Model T Ford

The Model T Ford cost \$850 in 1908; however by 1925 the price had fallen to \$290. How do we compare these values? If you wanted to compare the two years you would see that by using the CPI, the GDP deflator or the consumer bundle, \$850 in 1908 is equivalent to between \$1,485 and \$1,670 in 1925. Using the wage indicator we see that the labor cost (of the 1908 car in 1925 wages) was \$2,094 and by using the GDP per capita indicator it was \$1,957. Thus in 1925 the \$290 was less than 20% of its cost in 1908 using the price indexes and only 11 to 14% using the wage indicators and 15% using the GDP per capita.

If we wanted to consider the costs of the Model T using today's prices we would find that the \$850 cost in 1908 is \$21,900 in today's prices using the CPI, \$15,600 using the GDP deflator, about \$44,700 using the consumer bundle, \$92,2000 using the unskilled wage, \$141,600 using the manufacturing compensation, and \$128,100 when comparing using the GDP per capita. At this point the ford was a luxury for most everyone.

The \$290 in 1925, on the other hand, would be only \$3,800 in today's prices using the CPI, \$3,000 using the GDP deflator, \$7,500 using the consumer bundle, \$12,800 using the unskilled wage, \$15,600 using the manufacturing compensation, and \$19,000 when comparing using the GDP per capita. By then, the ford was an automobile

affordable by all.

Babe Ruth

Babe Ruth signed a contract on March 10, 1930 with the American League Base Ball Club of New York (The Yankees) to play baseball for the next two years at an annual salary of \$80,000. In 2012 the CPI was 15 times larger than it was in 1931, and the GDP deflator was 12 times larger. This means that if we are interested in Ruth's purchasing power of housing or meals, then he was "earning" the equivalence of about \$1,200,000 today.

In 2012, the average consumer unit spends about 32 times in dollars more than it spent 81 years earlier. Thus, if we want to compare Ruth's earnings using the index of what the average household buys, it would be over \$2,500,000 today. The relative cost of labor is 44 times (unskilled) and 53 time (manufacturing production workers) higher in 2012 than in 1931. So if we wanted to compare his wage to what someone selling hot dogs would earn, we could say his "relative wage" is three and a half to four million.

GDP per capita and GDP are 83 and 210 times larger in 2012 than they were in 1931. Thus Ruth's earnings relative to the average output would be \$6,600,000 today. Finally, as a share of GDP, Ruth's "output" that year would be \$16,800,000 in today's money.

Putting a man on the moon

Putting a man on the moon: During March (1966): NASA told Congress the "run-out cost" of the Apollo program (to put men on the moon) would be an estimated \$22.718 billion for the 13 year program that accomplished six successful missions of putting astronauts on the moon between July 1969 and December 1972. (http://www.hq.nasa.gov/office/pao/History/SP-4009/keyev4.htm ) According to Steve Garber, NASA History Web Curator, the final cost was between \$20 and \$25 billion.

How much would that be today? If we used the CPI, it would be \$160 billion, but this would not be a very good measure since the CPI does not reflect the cost of rockets and launch pads. Using the consumer bundle would not be relevant either. Using the broader based GDP deflator gives a present cost of \$124 billion. An alternative would be to use the production worker indicator as a rough measure of the labor cost in current terms and that would be \$196 billion. By using the GDP per capita, we are measuring the cost in terms of average product and would get a number of \$283 billion. Finally, a way to consider the "opportunity cost" to society, the best measure might be the cost as a percent of GDP, and that number would be \$453 billion. This amount over thirteen years would be \$35 billion per year. As a comparison, the NASA budget for the current fiscal year is approximately \$19 billion.

The 'real' price of gasoline

The "real" price of gasoline. Gasoline cost 27 cents a gallon in 1949 compared to around \$3.60 today.* How has the relative cost of buying gas changed over the last 63 years? Presented here are two tables computing the annual "real" cost using our seven indicators, one in 2012 dollars. and the other in 1949 dollars. While the two tables show the same trends, they do give a different perspective.

Using the 2012 table and the CPI and the GDP deflator, we see that gasoline was quite expensive in 1980 and 1981 and the cheapest in 1998 and 1999. Today, the real price using these two measures is higher than the period at the beginning of the 1980s.

By looking at the share of the Consumer Bundle and GDP per capita, the story is a bit different. In 1981, a gallon of gas took as much out of what the average consumer spent as \$3.90 does in 2011. And as a share of GDP per capita, gas was even more expensive in those earlier days with it at over \$5.02 in 1980 and more expensive in the earlier years. Both wage indexes show the prices then and now are similar.

The other table tells the story in a different way. Let us look at relative cost to a worker to fill up using 1949 dollars. That year the 27 cents it cost for a gallon of gas, took a certain share of the worker's wage. The interesting question is, has the cost as a share or percent of the worker's wage increased or decreased over time? The table shows that for the two wage rates and price of gasoline in other years, this cost has fallen. Since wages have increased faster than the price of gasoline, by 2012 an unskilled worker spends less than two-thirds as much, as a percent of wage, for a gallon of gasoline than the 1949 worker. For a production worker it is only half. The table shows that the \$3.61 a worker paid in 2012 would be comparable to only 19 to 23 cents (in 1949 prices "share" of the wage.

When we use the GDP per capita, the cost has fallen faster. Looking at the table shows that a gallon of gasoline costs around 13 cents a gallon (in 1949 prices) if measured as a "share" of the GDP per capita. This is because in 1949, 27 cents was .015% of per capita GDP, while in 2012, \$3.61 was .007%.

Finally, comparing its cost as a share of GDP, we see that in 1949 prices, it is about 6 cents. This means that a gallon gasoline was six times larger as a share of output in 1949 than it is today.

For the tables used here, I used the price of a gallon of leaded regular from 1949 to 1976, the average of the price of leaded regular and unleaded regular from 1977 to 1990 and the price of unleaded regular from 1991 to 2012.

Source: www.measuringworth.com

Category: Bank