SAC203/STA 221: PRINCIPLES OF

ECONOMICS I / ECONOMIC &

SOCIAL STATISTICS

By

Eliud Kayo
Introduction

Businesses use statistical methodology and thinking to make decisions about which products to
produce, how much to spend advertising them, how to evaluate their employees, how often to
service their machinery and equipment, how large their inventories should be, and nearly every
aspect of running their operations. The motivation for using statistics in the study of economics
and other social sciences is somewhat different. The objective of social sciences and economics in
particular is to understand how the social and economic systems function.

Basic Concepts

Economics is divided into two main branches: microeconomics and macroeconomics.

Microeconomics deals with the behavior of individual economic units. These units include
consumers, workers, investors, owners of land, business firms—in fact, any individual or entity
that plays a role in the functioning of our economy. Microeconomics explains how and why these
units make economic decisions.

Macroeconomics on the other hand deals with aggregate economic quantities, such as the level
and growth rate of national output, interest rates, unemployment, and inflation. But the boundary
between macroeconomics and microeconomics has become less and less distinct in recent years.
The reason is that macroeconomics also involves the analysis of markets, for example, the
aggregate markets for goods and services, labor, and corporate bonds.

Macroeconomists have become increasingly concerned with the microeconomic foundations of

aggregate economic phenomena, and much of macroeconomics is actually an extension of
microeconomic analysis.

Statistics is the methodology that we use to confront theories like the theory of demand and other
testable propositions with the facts. It is the set of procedures and intellectual processes by which
we decide whether or not to accept a theory as true, the process by which we decide what and what
not to believe. In this sense, statistics is at the root of all human knowledge. Statistics is the
systematic investigation of the correspondence of these theories with the real world. This leads
either to a wider belief in the ‘truth’ of a particular theory or to its rejection as inconsistent with
the facts.

Social statistics are a means of investigating and testing research questions and policy impacts
across different areas of people’s lives, to help one understand the society they live in.
 Demography is the scientific study of human populations, primarily with respect to their size, their
structure and their development. It includes the study of the size, structure, and distributions of
different populations and changes in them in response to birth, migration, aging, and death. It also
includes the analysis of the relationships between economic, social, cultural, and biological
processes influencing a population.

A) Economic Statistics

1. Gross Domestic Product (GDP)

Gross domestic product (GDP) is the standard measure of the value of final goods and services
produced by a country during a period. This is the market value of goods and services produced
within a selected geographic area (usually a country) in a selected interval in time (often a year).

The GDP of a country can be decomposed into four main components as:

𝑌 =𝐶+𝐼+𝐺+𝑋−𝑀

Where

𝑌 = GDP

𝐶 = Household consumption on durable goods, non-durable goods, and services

𝐼 = Investment by firms on capital equipment and inventories for future production of more goods
and services

𝐺 = Government expenditures such as purchase of goods and services by national and county
governments, and salaries for civil servants. Other forms of government disbursements like
social security payments are called government transfers and are not included in GDP
calculations.

𝑋 − 𝑀 = Net exports (Purchase of domestically produced goods by foreigners minus purchase of

foreign goods and services by local households and firms)

If the GDP of a country rises from one year to another, then:-

i) The economy is producing more goods and services

ii) The existing goods and services are being sold at a considerably higher price.
Under normal circumstances households and firms when calculating the GDP value, are more
interested in the total volume of goods and services available and not so much about the about the
prices at which these goods and services are sold. In order to cure for this, it is imperative to
calculate the real GDP of the economy as opposed to the nominal GDP.

Real GDP – Is the total value of final goods and services produced this year at constant prices that
prevailed during the base year.

Nominal GDP – Is the total value of final goods and services produced this year current prices.

Real GDP therefore corrects for inflation (rise in commodity prices).

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = 𝑥100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
The percentage change in the GDP deflator from one year to another defines the rate of inflation
for the economy.

GDP measures the level of expenditure and income in an economy. While GDP is the single most
important indicator to capture economic activities, it is not a good measure of societies’ well-being
and only a limited measure of people’s material living standards. This is because GDP is measured
based on the market value and does not therefore include: Leisure, childcare, environmental
quality, and equitable distribution of income.

Quiz

What happens to the real GDP, nominal GDP, and GDP deflator when:

i) The quantities of all goods and services produced rise but prices remain the same?
ii) The prices of all goods and services rise but quantities produced remain the same?
2. Consumer Price Index (CPI)

Consumer price index (CPI) is a measure of the overall cost of goods and services bought by a
typical consumer. The CPI is normally computed by the National Bureaus of Statistics (KNBS for
Kenya), with the intention to measure the overall changes in the consumer’s basket of goods, which
affect the real purchasing power of consumers’ income and welfare. Since the prices of different
goods and services do not all change at the same rate, a price index can only reflect their average
movement.

Consumer price indices can be used to measure: i) the rate of price inflation as perceived by
households, or ii) changes in their cost of living (that is, changes in the amounts that households
need to spend in order to maintain their standard of living).

CPIs are calculated as weighted averages of the percentage price changes for a specified consumer
basket of goods. The weights reflect the consumer goods’ relative importance in household
consumption in a given period. The index therefore greatly depends on how appropriate and timely
the weights are.

Since CPIs provide timely information about the rate of inflation, they are widely used for various
purposes such as:

 To index pensions and social security benefits for citizens.

 To index other payments, such as interest payments or rents, or the prices of bonds.
 Being used as a proxy for the general rate of inflation, even though they measure
only consumer inflation. They are therefore used by central banks to set inflation
targets for purposes of monetary policy.
 To further compute other indices, such as the price indices used to deflate
household consumption expenditures in national accounts, or the purchasing power
parities used to compare real levels of consumption in different countries.

Types of CPI Indices

There are three most commonly used CPIs computed and adopted by various countries across the
world:

i) Lowe Indices
ii) Laspeyres Indices
iii) Paasche Indices
 i) Lowe Index

The Lowe index is obtained by defining the price index as the percentage change between the
periods compared, in the total cost of purchasing a given set of quantities (consumer basket).

The Lowe index, 𝑃𝐿0 , is defined as follows:

∑𝑛𝑖=1 𝑃𝑖𝑡 𝑞 𝑖
𝑃𝐿0 = 𝑛
∑𝑖=1 𝑃𝑖0 𝑞 𝑖
Where 𝒏 are the products in the basket with 𝒑𝒊 prices and 𝒒𝒊 quantities.

For practical reasons, the basket of quantities used for CPI purposes usually has to be based on a
survey of household consumption expenditures conducted in an earlier period than either of the
two periods whose prices are compared. For example, a monthly CPI may run from January 2010
onwards, with January 2010 = 100, but the quantities may be derived from an annual expenditure
survey made in 2005 or 2006, or even spanning both those years. As it takes a long time to collect
and process expenditure data, there is usually a considerable time lag before such data can be
introduced into the calculation of CPIs.

The period whose quantities are used in a CPI is described as the weight reference period, denoted
as period b. Period 0 is the price reference period. Period b is therefore likely to precede 0, at least
when the index is first published. However, b could be any period, including one between 0 and t,
if the index is calculated sometime after t. The Lowe index using the quantities of period b can be
therefore rewritten as follows:

∑𝑛𝑖=1 𝑝𝑖𝑡 𝑞𝑖𝑏

𝑃𝐿0 =
∑𝑛𝑖=1 𝑝𝑖0 𝑞𝑖𝑏
The Lowe index can be further derived to obtain the Laspeyres Index or the Paasche Index by
interchanging the reference period b with either 0 or t.

ii) Laspeyres price index