David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 15 Introduction to macroeconomics
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Indeed, when the euro was first launched as a currency, the decision to make the most valuable note €500
(much more valuable than the largest dollar banknote, the $100 bill) led to fierce discussion as to whether the
euro would replace the dollar as the preferred currency of crooks - and in 2010 it was taken out of currency
in the UK for precisely that reason.
Another way is to guess people's income by
studying what they spend. Maria Lacko has used
the stable relationship between household use of
electricity and its main determinants - income
and weather temperature - to estimate incomes SQQIUllO
from data on electricity consumption and
Picture: A €500 banknote and a $100 bill.
temperature. She confirms two popularly held
views. The hidden economy is large both in former
communist economies, where the new private sector is as yet unrecorded, and in several Mediterranean
countries with a history of trouble getting their citizens to pay tax. She found that the size of the hidden
economy might be around 20-30 per cent of reported GDP in the countries of Eastern Europe and the
Mediterranean, but probably only 5-10 per cent of the size of GDP in the US and UK. If we measured this
properly, GDP would therefore be much larger.
Another way to estimate the hidden economy is to conduct surveys and offer people immunity if they tell the
truth. Recent work by Friedrich Schneider is quoted by the UK National Audit Office (2008). His estimates
are shown in the table below.
The hidden economy {0/o of national income)
Belgium Sweden Canada Australia UK us
22 19 16 14 12 9
-
Source: National Audit Office (2008) Tackling the Hidden Economy, The Stationery Office.
Nominal and real GNP
Nominal GNP measures
GNP at the prices prevailing
when income was earned.
Real GNP, or GNP at
constant prices, adjusts for
inflation by measuring GNP
in different years at the prices
prevailing at some particular
date known as the base year.
The GNP deflator is the ratio
of nominal GNP to real GNP
expressed as an index.
Since it is physical quantities of output that yield people utility or happiness, it can
be misleading to judge the economy's performance by looking at nominal GNP.
Table 15.4 presents a simple hypothetical example of a whole economy. Nominal
GNP rises from £600 to £1470 between 1980 and 2010. If we take 1980 as the base
year, we can measure real GNP in 2008 by valuing output quantities in 2010 using
1980 prices. Real GNP rises only from £600 to £860. This rise of 43 per cent in real
GNP gives a truer picture of the extra quantity of goods made by the economy as
a whole.
The GNP deflator
Chapter 2 introduced the consumer price index (CPI), an index of the average
price of goods purchased by consumers. The most common measure of the
inflation rate in the UK is the percentage rise in the CPI over its value a year earlier.
However, consumption expenditure is only one part of GNP, which also includes investment, government
spending and net exports. To convert nominal GNP to real GNP, we need to use an index showing what is
happening to the price of all goods. This index is called the GNP deflator.
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