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Doctoral Program and Advanced Degree in Sustainable Energy Systems
Doctoral Program in Mechanical Engineering
Doctoral Program in Environmental Engineering
Ecological Economics
Lecture 07
Tiago Domingos
Assistant Professor
Environment and Energy Section
Department of Mechanical Engineering
Temporal Comparison - Real vs Nominal
• Inflation – changes in consumer prices
• Affects:
– Exports,
– Erosion of consumer power
– Distorts the intertemporal comparisons of variables in monetary
units, e.g., evaluating the profitability of an investment.
GDP   Pi  Qi
i
• What part of the change in national accounts aggregates at current
prices comes from a change in the quantities (changes in volume)
produced and what part comes from a change in prices
(inflation)?
Temporal Comparison - Real vs Nominal
Item
Quantity
Price
2007
Nominal GDP in:
- 2007, €200
- 2008, €575
Bread
100
€1.00
Butter
20
€5.00
Bread
160
€ 0.50
Butter
22
€ 22.50
2008
Growth rate: 187,5 %
• What is the nominal GDP in each year and the nominal GDP
growth rate?
• What does the above value represent?
• How to obtain real (volume) growth changes?
Price Level and CPI
• Consumer Price Index (CPI)
– It is based on a fixed (changes every 5 years) basket of goods that are
normally an important part of households’ consumption.
• 1 – Fix the Basket – which prices are most important to the typical consumer? Put
weights by surveying consumers and finding the basket of goods and services that the
typical consumer buys.
• 2 – Find the prices for each good and service in the basket.
• 3 – Compute the basket’s cost (price times quantity)
• 4 – Choose a base year and compute the CPI Formula
• 5 – Compute inflation as the rate of change in CPI
Price Level and CPI
Item
Quantity
Price
2007
Bread
100
€1.00
Butter
20
€5.00
2008
Bread
160
€ 0.50
Butter
22
€ 22.50
• Basket of goods: 5 Breads, 1 Butter
• What is the inflation rate?
• Inflation rate = rate of change of price level,
• 150% = (250-100)/100
Cost of Basket
CPI
€10
100
€25
250
Price Level and CPI
Item
Nominal GDP
CPI
Real GDP
2007
€200
100
€200
2008
€575
250
€230
• Using the CPI to deflate Vyear x to Vbase year:
• Vbase year = (CPIbase year ÷ CPIyear x ) Vyear x.
• What is the real GDP and its real growth rate?
• 15 %
• What does the above value represent, compared to nominal growth 187,5%?
CPI in Portugal
• First national CPI (PT) in 1977, after “inquérito às despesas das
famílias” 1973/1974.
• Increase in number of items, establishments and reference population
• Now: Fixed base year using average prices of 2008 (Changed in 1976,
1983, 1991, 1997)
• CPI is in fact composed of several indexes for different classes of
consumption (COICOP - Classification Of Individual COnsumption by
Purpose)
• More than 700 items (goods and services) in more than 10 000
establishments yielding more than 70 000 prices on a monthly basis for a
given reference population (total population).
• These basket is changed every 5 years.
CPI in Portugal: Basket
COICOP (1) Divisions, Groups and Classes
Year: 2009
Jan Feb Mar
Apr
Food and non alcoholic beverages
Food
Bread and cereals
Meat
Fish
Milk, cheese and eggs
Oils and fats
Fruit
Vegetables
Sugar, jam, honey, chocolate and confectionery
Food products n.e.c.
Non-alcoholic beverages
Coffee, tea and cocoa
Mineral waters, soft drinks, fruit and vegetable juices
99,9
99,9
101,1
101,8
98,9
99,0
98,2
95,8
100,7
101,1
99,5
100,1
101,5
99,6
99,4
99,4
101,3
100,2
98,4
97,3
96,4
96,1
102,8
101,1
99,9
99,8
101,0
99,3
98,8
98,8
101,1
99,7
95,5
96,4
94,4
97,9
104,9
100,9
100,4
100,0
100,8
99,7
98,3
98,2
101,2
99,4
93,4
95,3
93,1
98,7
105,3
101,0
100,7
100,7
101,6
100,4
Alcoholic beverages, tobacco
Alcoholic beverages
Spirits
Wine
Beer
Tobacco
101,4
102,4
99,9
103,0
101,9
101,0
101,5
102,5
101,2
103,0
101,4
101,0
103,1
102,4
100,1
103,5
100,4
103,2
103,1
102,4
99,5
103,7
100,1
103,3
Clothing and footwear
Clothing
Clothing materials
Garments
Other articles of clothing and clothing accessories
Cleaning, repair and hire of clothing
Shoes and other footwear including repair and hire of footwear
Footwear
Repair and hire of footwear
88,5
87,7
101,0
87,1
88,2
100,8
90,9
90,6
102,2
85,8
85,1
100,3
84,3
87,5
101,1
87,8
87,5
102,5
103,0
103,2
100,2
103,4
95,7
101,2
102,2
102,2
102,6
103,7
103,8
102,0
104,0
97,5
101,4
103,4
103,4
102,7
Housing, water, electricity, gas and other fuels
Actual rentals for housing
Actual rentals paid by tenants including other actual rentals
Maintenance and repair of the dwelling
Materials for the maintenance and repair of the dwelling
Services for the maintenance and repair of the dwelling
Water supply and miscellaneous services relating to the dwelling
Water supply
Refuse collection (2)
Sewerage collection (2)
Other services relating to the dwelling n.e.c.
Electricity, gas and other fuels
Electricity
Gas
Liquid Fuels (2)
Solid fuels
101,8
101,4
101,4
101,4
101,9
101,1
103,2
101,9
101,4
102,5
105,5
101,0
104,2
95,1
97,2
100,2
101,9
101,7
101,7
101,4
102,0
101,1
104,0
102,9
101,8
104,4
105,5
100,8
104,2
94,5
96,4
100,5
102,0
102,2
102,2
101,5
102,2
101,1
104,4
103,4
102,6
104,7
105,5
100,5
104,2
94,5
90,9
98,4
101,9
102,4
102,4
101,8
102,6
101,3
104,6
103,6
103,9
104,7
105,5
100,1
104,2
92,6
95,0
98,6
Furnishings, household equipment and routine maintenance of the house
Furniture and furnishings, carpets and other floor covering
Furniture and furnishings
Carpets and other floor coverings
Repair of furniture, furnishings and floor coverings
Household textiles
Household textiles
Household appliances
Major electric household appliances
Small electric household appliances
Repair of household appliances
Glassware, tableware and household utensils
Glassware, tableware and household utensils
Tools and equipment for house and garden
Major tools and equipment for house and garden
Small tools and miscellaneous
Goods and services for routine household maintenance
Non-durable household goods
Domestic services and household services
101,9
99,8
99,8
99,4
101,9
100,3
100,3
100,5
100,4
100,6
101,5
100,8
100,8
101,6
100,3
101,7
103,5
100,4
105,6
101,7
99,4
99,4
98,8
102,3
99,3
99,3
100,4
100,2
100,7
102,4
100,8
100,8
101,9
100,2
102,3
103,4
100,0
105,6
101,8
99,6
99,6
98,1
102,4
98,8
98,8
100,5
100,3
101,0
102,6
100,9
100,9
101,8
100,4
102,1
103,5
100,4
105,6
101,8
99,6
99,5
99,5
102,8
99,4
99,4
100,4
100,1
100,9
102,8
101,1
101,1
101,9
99,9
102,5
103,5
100,3
105,7
Health
Medical products, appliances and equipment
Pharmaceutical products
Other products and medical appliances
Therapeutic appliances and equipment
Out-patient services
Medical services
Dental services
Paramedical services
Hospital services
99,6
98,2
97,2
101,3
101,1
100,7
100,9
100,7
100,0
100,7
99,3
98,3
97,2
101,4
101,3
100,9
101,3
100,7
100,2
95,7
99,3
98,2
97,0
101,4
101,6
100,9
101,4
100,7
100,2
95,7
99,4
98,4
97,1
101,1
101,9
101,1
101,5
100,9
100,3
95,9
Transport
Purchase of vehicles
Motor cars
Motor cycles
Bicycles
Operation of personal transport equipment
Spare parts and accessories
Fuels and lubricants
Maintenance and repair of personal transport equipment
Services in respect of personal transport equipment
Transport services
Passenger transport by railway
Passenger transport by road
Passenger transport by air
Passenger transport by sea and inland waterway
Combined passenger transport
Other purchased transport services
93,6
101,5
101,5
100,6
100,8
86,2
98,1
78,6
100,8
101,8
95,9
101,0
102,8
79,7
103,2
100,1
99,1
94,7
101,4
101,4
101,2
100,4
88,0
97,5
80,9
101,2
101,9
97,7
101,7
103,3
85,8
103,5
100,1
99,1
94,4
101,3
101,3
101,8
99,6
87,6
96,7
80,3
102,1
102,0
96,8
101,7
103,4
82,0
103,5
100,1
99,1
95,7
101,1
101,1
102,9
98,9
89,8
96,2
83,1
102,7
102,1
98,3
101,7
103,4
88,0
105,9
100,1
99,3
Communication
98,3 98,2 99,3 99,3
Postal services
102,2 103,9 103,9 103,9
Postal services
102,2 103,9 103,9 103,9
Telephone and telefax equipment
89,0 88,6 88,5 89,0
Telephone and telefax equipment
89,0 88,6 88,5 89,0
Telephone, telegraph and telefax services 98,4 98,3 99,5 99,5
Education
Pre-school and primary education
Pre-school and primary education
Primary and secondary school
Primary and secondary school
Higher education
Higher education
Other types of education
Other types of education
102,5
102,8
102,8
100,9
100,9
103,0
103,0
102,6
102,6
102,7
102,8
102,8
101,2
101,2
103,0
103,0
103,1
103,1
102,7
102,8
102,8
101,2
101,2
103,0
103,0
103,2
103,2
102,7
102,8
102,8
101,2
101,2
103,0
103,0
103,4
103,4
Hotels and restaurants
Catering services
Restaurants, cafes, bars and like
Canteens
Accommodation services
101,3
101,7
101,2
106,1
89,5
101,5
102,1
101,5
106,3
87,0
101,9
102,4
101,9
106,5
89,6
102,4
102,5
102,0
106,7
98,9
Recreation and culture
Audio-visual, photographic and data processing equipment
Equipment for the reception, recording and reproduction of sound and pictures
Photographic and cinematographic equipment and optical instruments
Data processing equipment
Recording media for pictures and sound
Repair of audio-visual, photographic and data processing and accessories
Other major durables for recreation and culture
Major durables for outdoor recreation (2)
Major durables for indoor recreation including musical instruments
Other recreational items and equipment, garden and pets
Games, toys and hobbies, equipment for sport camping and open-air recreation
Other recreational items for hobbies and recreation
Gardening
Pets and related products
Recreational and cultural services
Recreation and sporting services
Cultural services
Games of chance
Newspapers, books and stationery
Books
Newspapers and periodicals
Miscellaneous printed materials
Package holidays
Package holidays
99,1
96,1
96,0
90,9
92,5
99,0
102,7
98,0
100,0
97,6
102,1
97,0
98,8
108,7
102,1
99,8
98,4
100,4
100,0
102,1
101,6
103,5
100,6
91,8
91,8
99,1
94,2
94,6
91,1
90,2
96,6
103,2
98,4
100,2
98,4
103,3
95,8
98,9
115,2
102,6
100,2
100,1
100,6
100,0
102,0
101,3
103,6
100,7
90,8
90,8
98,4
92,2
92,5
90,0
87,9
94,8
103,7
98,9
100,2
99,3
100,0
95,6
98,9
98,1
102,7
100,3
100,4
100,7
100,0
101,5
100,0
103,6
101,5
91,2
91,2
98,6
92,0
92,1
88,8
87,4
95,7
104,6
98,9
100,2
99,4
99,7
94,7
99,3
94,4
103,8
101,3
100,3
102,6
100,0
101,7
100,4
103,7
101,6
90,0
90,0
CPI in Portugal: Basket
Miscellaneous goods and services
Personal care
Hairdressing salons and personal grooming establishment
Articles for personal care
Products for personal care
Personal effects n.e.c.
Jewellery, clocks and watches
Other personal effects
Social protection
Social protection services
Insurance
Insurance connected with the dwelling
Insurance connected with health (2)
Insurance connected with transport
Other insurance (2)
Financial services n.e.c.
101,4
101,2
101,2
101,0
101,2
102,2
104,1
99,5
103,0
103,0
100,5
102,2
100,9
100,0
100,6
100,7
101,5
101,5
101,4
101,4
101,6
100,8
103,1
97,8
103,1
103,1
100,3
102,2
101,7
99,6
100,6
100,7
101,6
101,8
101,7
101,3
101,9
101,4
103,2
98,8
103,1
103,1
100,3
102,2
101,7
99,6
100,6
100,8
101,9
102,2
102,0
100,8
102,3
102,1
103,7
99,7
103,1
103,1
100,3
102,2
101,7
99,5
100,6
101,0
• Example:
• Washing machine; white; frontal door; 5 kg of clothes; 2200 W; 12 – 14
programs
• Pants; Wool (45%) and polyester (55%), two lateral pockets; one back
pocket, no fold; good finishings, 46/48.
Inflation rate in Portugal [%]
35
30
25
20
15
10
5
0
1961
1966
1971
-5
Source: AMECO database
1976
1981
1986
1991
1996
2001
2006
Real vs. Nominal (Portugal) [Mrd euros]
2000000
1800000
1600000
Gross domestic product at 2000 market
prices
1400000
Gross domestic product at current market
prices
1200000
1000000
800000
600000
400000
200000
0
1960
1965
1970
Source: AMECO database
1975
1980
1985
1990
1995
2000
2005
2010
Problems with the CPI
• Objective: Measure changes in the cost of living
• Substitution bias:
• prices change differently
basket is fixed.
consumers buy more of cheaper goods, yet the
• Overstates the increase in prices
• Technological progress
• New goods
more variety
each € is more valuable since it buys more
goods. E.g., introduction of VCRs
• CPI even with the revised basket never shows the decrease in life cost due
to new products.
• Quality Change:
• Quality increases
stays the same
value of one € decreases even if the price of the good
• Prices are adjusted but quality is hard to measure
• No environmental goods, …
Present Value of Money
• Present Value
– Conversion of money flows to their present value
T
1
VFt
t


1

i
t 0
NPV  
•
•
•
•
•
NPV: Net Present Value
i: interest rate
VFt(t): value at instant t
If VF is in current prices then i is the nominal interest rate
If VF is in constant prices then i is the real interest rate
Nominal vs. real interest rates
The Fisher relation
1  nominal   (1  real)(1  inflation
For low rates, this is approximately equal to
nominal  real  inflation
)
Present Value of Utility
• Welfare
– Discrete time
1
U t 
t
t 0 1   
T
W
– Continuous time
T
W   e-tU t dt
t 0
Discount Rate
Justification and Components
•
The same monetary flow at different instants does not have the same
value (time preference)
– CONSUMPTION: Uncertainty
• Being alive in the future (individual vs. society)
• Preferences in the future
• Value of the benefit or the cost
– CONSUMPTION: Impatience
– PRODUCTION: Capital productivity (opportunity cost of capital)
•
Under certain conditions, the discount rate is equal to the real market
interest rate
consumption
discount rate
pure time
preference rate
C
r   
C
utility
discount rate
.
  pL
variation in survival
probability
per capita consumption
growth rate
elasticity of the marginal
utility of consumption
Turner et al. (1994), pp. 102-106.