Toward a New Theory of GDP

Traditional GDP accounting has obvious defects. Nominal GDP aggregates real outputs at current prices; it captures changes in relative commodity prices or price structure but fails to exclude inflation or deflation. Real GDP aggregates real outputs at base-period prices, removing inflationary or deflationary effects but ignoring changes in relative prices. To overcome limitations of nominal and real GDP, this paper proposes the concepts of a new GDP deflator and new GDP. The new GDP deflator equals the ratio of total current prices evaluated at base-period output to total base-period prices. New GDP equals nominal GDP divided by the new GDP deflator, i.e., nominal GDP adjusted by the new GDP deflator. Unlike conventional nominal and real GDP, new GDP excludes inflation and deflation while fully incorporating changes in relative commodity prices. New GDP possesses favorable properties: it remains unchanged under proportional increases in all current prices; it rises proportionally with changes in all current outputs; it rises with increases in current output of any commodity; it rises when current prices of relatively advantageous commodities increase and falls when current prices of relatively disadvantageous commodities increase, and is unaffected by price changes of commodities with neither relative advantage nor disadvantage. In summary, new GDP is invariant under proportional price changes (inflation or deflation), yet responds to disproportional price shifts (relative price changes). Specifically, it rises (falls) with price increases for commodities growing faster (slower) than the average economic growth rate and remains unaffected by price changes for commodities growing at the average economic growth rate.