As can be seen from problems 5 and 6, the use of base year prices to compute the rate of change of real GDP and the rate of infl ation has some very unattractive properties. Every time a new base year is selected (e.g., to refl ect the growing share of services in GDP), all past growth rates of real GDP and all past rates of infl ation based on the GDP defl ator have to be revised. To avoid these problems, virtually all statistical agencies around the world, including Statistics Canada, started using chain-type indexes in 1995. In this problem, we shall see, using the economy described in problem 5, how chain-type indexes are constructed. Further discussion of this method can be found in the appendix to this chapter.

a. Construct real GDP for years 1998 and 1999 for the economy described in problem 5 by using the average price of each good over the two years.

b. By what percentage does real GDP increase from 1998 to 1999?

c. What is the GDP defl ator in 1998 and 1999? What is the rate of infl ation using the chain-type defl ator?

d. Do you fi nd this method of construction of real GDP growth and of the infl ation rate attractive? Why, or why not?