Question

Why do national income accountants compare the market value of the total outputs in various years rather than actual physical volumes of production? What problem is posed by any comparison over time of the market values of various total outputs? How is this problem resolved?

Short answer

The national income accountants compare total output in terms of market value rather than physical volume as it provides a common unit of measurement.

The use of market value can overestimate or underestimate the country’s production.

The problem can be resolved by using real GDP for comparison.

Step-by-step solution

Use of market value instead of physical volumes to compare output over years

The dollar value or the market value provides a common unit of measurement that helps in adding the output of different goods and services (measured in different physical units) to give the total production of the economy and how it is changing over time.

For example, A small country X produces 2 tons of good A of value $1000 and 30 liters of good B of value $500 in 2019. You can not add tons with liters but can add the dollar value of good A and dollar value of good B to calculate the total production

Therefore, the market value shows that the GDP was $1500 ($1000+$500) in 2019.

Problem of using  market value for comparing outputs

Using the market value for comparing output can exaggerate or overestimate the total production due to inflation.An economy could be producing lesser physical output, yet the higher prices result in higher GDP value.Similarly, deflation can result in an underestimation of the GDP with the same physical output.

For example, a country’s GDP is $2 billion in 2019 and $3 billion in 2020. The physical volume of production has decreased, but inflation resulted in overestimating the total production. Similarly, if the physical output production increased, but the GDP fell from $2 billion (2019) to $1 billion in 2020, the total production is underestimated.

Solving the problem of using market value for comparing outputs 

The problem of using market value, that is, overestimation and underestimation of production, can be solved by using real GDP, where the base year prices are taken to calculate the market value. Hence, the production is adjusted for inflation. The nominal GDP (using current prices) can be higher or lower than the real GDP.