10.01  In a system of economic accounts, all the flows and stocks are expressed in monetary units. The monetary unit is the only common denominator which can be used to value the extremely diverse transactions recorded in the accounts and to derive meaningful balancing items.

10.02  When time comparisons of flows and stocks are concerned, equal importance is to be attached to the accurate measurement of changes in prices and in volumes. In the short term, observation of price changes is of no less interest than the measurement of the volume of supply and demand. On a longer-term basis, the study of economic growth has to take account of movements in the relative prices of the different types of goods and services.

10.03  The general rule for comparisons in space is that accurate measures must be made for both the volume and the price components of the economic aggregates. As the spread between the Laspeyres and Paasche formulae often is significant in spatial comparisons, the Fisher index formula is the only acceptable one for this purpose.

10.04  Economic accounts have the advantage of providing a suitable framework for constructing a system of volume and price indices as well as ensuring the consistency of the statistical data. The advantages of an accounting approach can be summarised as follows.

1. On a conceptual level, the use of an accounting framework covering the entire economic system requires the prices and physical units for the different products and flows in the system to be specified consistently. In a framework of this type, the price and volume concepts for a given group of products are defined identically in both resources and uses.
2. On a statistical level, the use of the economic accounts framework imposes accounting constraints which must be respected at both current prices and in volume terms and will normally require some adjustments to be made to ensure consistency of the price and volume data.
3. Furthermore, the creation of an integrated system of price and volume indices in the context of a system of economic accounts provides the national accountant with extra checks. Assuming the existence of a balanced system of supply and use tables at current prices, the construction of such balanced tables in volume terms means that a system of implicit price indices can be automatically derived. Examination of the plausibility of these derived indices can lead to revision and correction of the data in volume terms and even, in some cases, of the values at current prices.
4. The accounting approach permits the measurement of price and volume changes for certain balancing items in the accounts, the latter being derived by definition from the other elements in the accounts.

10.05  Despite the advantages of an integrated system based on the balance, both overall and by industry, of transactions in goods and services, it has to be acknowledged that the price and volume indices thus obtained do not meet all needs or answer all possible questions on the subject of change in prices or volume. Accounting constraints and the choice of price and volume index formulae, although essential for the construction of a coherent system, can sometimes be a hindrance. There is also a need for information for shorter periods such as months or quarters. In such cases, other forms of price and volume indices may prove useful.

10.06  Amongst the flows, which appear in economic accounts at current prices, there are some, mainly concerning products, where the distinction between changes in price and volume is similar to that made at microeconomic level. For many other flows in the system, the distinction is far less obvious.

10.07  The objective and the procedure followed when measuring the real purchasing power of income estimates are different from those followed when deflating goods and services and balancing items. For flows of goods and services an integrated system of price and volume indices can be established, which provides a consistent framework for measuring economic growth. The valuation in real terms of flows of income uses price indices which are not strictly linked to the income flow. So the choice of price for income growth can differ according to the objectives of the analysis: there is no unique price identified in the integrated system of price and volume indices.

10.08  The systematic division of changes in current values into the components 'changes in price' and 'changes in volume' is restricted to flows representing transactions, recorded in the goods and services accounts and in the supporting supply and use framework. It is carried out both for the data relating to individual industries and products, and for those relating to the total economy. Flows which are balancing items, such as current added, cannot be directly factored into price and volume components; this can only be done indirectly using the relevant flows of transactions.

1. the balance of the goods and services account must for any sequence of two years be obtained at both current prices and in volume terms;
2. each flow at the level of the total economy must be equal to the sum of the corresponding flows for the various industries.

A third constraint, not inherent in the use of an accounting framework but resulting from a deliberate choice, is that every change in the value of transactions must be attributed either to a change in price or to a change in volume, or to a combination of the two.

10.09  The items to be considered when constructing such an integrated set are as follows:

10.10  In addition to the price and volume measures considered above, the following aggregates can also be subdivided into their own price and volume components. The objectives for these measures vary.

10.11  Compensation of employees is an element of income. For the purpose of measuring purchasing power, it can be valued in real terms by deflating with an index reflecting the prices of products purchased by employees. Other income elements too, such as disposable income of households and national income, can be measured in real terms in the same general way.

10.12  Volume and price indices can only be derived for variables that have price and quantity elements. The notions of price and quantity are closely linked to that of homogeneous products, i.e. products for which it is possible to define units which are all considered equivalent and which can thus be exchanged for the same monetary value. It is thus possible to define the price of a homogeneous product as the amount of money for which each product unit can be exchanged.

10.13  Another way of defining a homogeneous product is to say that it consists of units of the same quality.

10.14  In practice, however, two units of a product with identical physical characteristics may be sold at different prices for two types of reasons.

1. Two units with identical physical characteristics can be considered as not being equivalent if they are sold in different places, at different periods or according to different conditions. In this case, the units have to be regarded as corresponding to different homogeneous products.
2. Two units with identical physical characteristics can be sold at different prices, either due to lack of information, or to restrictions brought to purchase freedom, or to the existence of parallel markets. In this case, the units have to be regarded as belonging to the same homogeneous product.

A homogeneous product can thus also be defined as a product of which all units would be sold at the same price in perfect competition. In the absence of perfect competition, the homogeneous product price is defined by the average price of its units. Therefore, in national accounts, for each homogeneous product there is one price and only one price, so that it is possible to apply general rules of valuation of products.

10.15  Lack of information means that purchasers may not always be properly informed about existing price differences and may therefore inadvertently buy at higher prices. This, or the opposite, may occur also in situations where individual buyers and sellers negotiate or bargain over the price. On the other hand, the difference between the average price of a good purchased in a market or a bazaar, where such bargaining often occurs, and the price of the same good sold in a different type of retail outlet, such as a department store, should normally be treated as reflecting differences in quality due to different sales conditions.

10.16  Price discrimination []

See P&V measures paragraph 2.1.4

Handbook on prices and volume measures in national accounts

implies that sellers may be in a position to charge different prices to different categories of purchasers for identical goods and services sold under exactly the same circumstances. In such cases, there is no or limited freedom of choice on the part of a purchaser belonging to a special category. The principle adopted is that variations in price are to be regarded as price discrimination when different prices are charged for identical units sold under exactly the same circumstances in a clearly separable market, i.e. when different prices are charged for the same homogeneous product. Price variations due to such discrimination do not constitute differences in volume.

10.17  Parallel markets may exist for several reasons. Buyers may be unable to buy as much as they would like at a lower price because there is insufficient supply available at that price, and a secondary, parallel market, where higher prices are quoted, may exist. There is also the possibility that a parallel market exists, where sellers can charge lower prices because they can avoid certain taxes.

10.18  Thus, if quality is defined by all the characteristics common to all units of a homogeneous product, differences in quality are reflected by the following factors:

1. physical characteristics;
2. deliveries in different locations;
3. deliveries at different times of the day or at different periods of the year;
4. differences in conditions of sale or the circumstances or environment in which goods or services are supplied.

10.19  The introduction of the notion of volume in national accounts rests on the desire to eliminate the effect of price variation in the pattern of values expressed in monetary units, and it thus appears as an extended use of the notion of quantity for groups of products. In fact, for a given homogeneous product the equation v = p x q allows the change of a value over time to be broken down into change of price and change of quantity. In practice, however, there are too many homogeneous products to be dealt with individually, with the result that national accountants have to work at a more aggregated level. At this aggregated level, however, the equation v = p x q is no longer useful since, while it is possible to aggregate values, it is not meaningful to aggregate quantities in order to derive prices.

10.20  There is however a simple way of breaking down the change in the value of a set of homogeneous products between two periods, one of which is considered the base period and the other the current period. The effect of change in price can be offset by calculating what the value of the set of products would have been if there had been no change in prices, i.e. by applying the prices of the base period to the quantities of the current period. This value at prices of the base period defines the notion of volume.

10.21  The main advantages of using Paasche price indices and Laspeyres volume indices are the interpretation and calculation simplicity and the additivity property in the supply and use balances.

10.22  Chained indices present the drawback that they lead to volumes having no additivity so that they cannot be used in the balancing procedures of products based on supply and use tables.

10.23  The non-additive volume data calculated with chain indices are to be published without any adjustment. This method is transparent and indicates to users the extent of the problem. This does not preclude the possibility that there may be circumstances in which compilers may judge it preferable to eliminate the discrepancies in order to improve the overall consistency of the data. When reference year values are extrapolated by chain volume indices, an explanation has to be provided to users concerning the absence of additivity in the tables.

10.24  In practice, since it is impossible to measure prices and quantities for all the homogeneous products of an economy, volume or price indices are calculated using samples of representative homogeneous products, the underlying idea being that the volumes or prices of products not included in the sample change in the same way as the sample average. It is therefore necessary to use a product classification which is as detailed as practicable so that each product identified has maximum homogeneity, regardless of the level of detail used in the presentation of results.

10.25  In view of the equation linking the value, price and volume indices, only two indices need to be calculated. Usually, the value index is obtained directly by simply comparing the overall values for the current and base periods. It is then a matter of choosing between a price index and a volume index to be calculated. In most cases the assumption of parallel change which underlies the method is proven more by prices than by volumes because the prices of different products are often significantly influenced by certain common factors such as the cost of raw materials and wages. In this case, the price index is to be calculated using a sample of products of constant quality over time, with quality being determined not only by the physical characteristics of the product but also by the conditions of sale, as explained above. In this way all the variations in the overall value caused by structural changes among the various products will appear as variations in volume and not in price.

10.26  The method of calculating price and volume indices outlined above assumes that the products exist in both successive years. In actual fact, however, many products appear and disappear from one year to the next and the price and volume indices need to reflect this. Where volume is defined using the prices of the previous year, there is no particular difficulty in the case of products which existed in the previous year but which no longer exist in the current year, since they are simply linked to a zero quantity for the current year. The problem is more complicated in the case of new products, since for the previous year it is not possible to measure the price of a product which does not exist.

10.27  For transactions in services it is frequently more difficult to specify the characteristics which determine the physical units, and differences of opinion may arise concerning the criteria to be used. This difficulty may concern important industries such as financial intermediation services, wholesale and retail trade, services to enterprises, education, research and development, health or recreation. The choice of physical units for such activities is presented in Handbook on price and volume measures in national accounts [1]

Handbook on prices and volumes measures in national accounts

.

10.28  The establishment of a comprehensive system of price and volume indices covering all supply and uses of goods and services involves a particular difficulty when measuring the output of non-market services. Such services differ from market services in that they are not sold at a market price and their value at current prices is calculated as the sum of the costs incurred. Those costs are: intermediate consumption, compensation of employees, other taxes less subsidies on production and consumption of fixed capital.

10.29  In the absence of a unit market price, the unit cost of a non-market service can be considered as the equivalent to the price. In fact, the price of a market product corresponds to the expenditure which the purchaser must incur in order to take possession of it, while the unit cost of a non-market service corresponds to the expenditure which society must incur in order to make use of it. Thus, where it is possible to define units of quantity for non-market services, it is also possible to apply the general principles for calculating volume and price indices which are outlined above.

10.30  It is difficult, however, to define units of quantity for collective non-market services, such as services in connection with general government, justice or defence. In this case, therefore, other methods need to be used by analogy with the general method. This method defines volume on the basis of prices of the previous year, i.e. it defines volume as the expenditure which purchasers would have incurred if prices had not changed. This latter definition may be used when it is not possible to define a unit of quantity provided that it is applied, not to a unit of product, but to the expenditure as a whole. Since the value of a non-market service is determined by the costs involved, it is thus possible to calculate the volume by the value of the costs at base period prices, i.e. by the value at base period prices of intermediate consumption, compensation of employees, other taxes net of production subsidies and consumption of fixed capital. This method is known as the input method. The calculation in volume terms of the compensation of employees, consumption of fixed capital, taxes and subsidies on production is covered in the paragraphs which follow.

1. The unit cost criterion: two units of non-market services being considered equivalent if they have the same unit cost. This criterion is based on the idea that, collectively, those who benefit from public services are also those who decide and pay for them. For example, citizens decide on public services via their representatives and pay for them by their taxes. Under such conditions, citizens cannot be expected to pay different prices for service units that they consider equivalent. Thus, according to this criterion, two service units of different cost have to be regarded as corresponding to different products, and a non-market homogeneous product is characterised by the unicity of its unit cost.
2. The outcome criterion: two units of non-market services being considered equivalent if they give the same outcome. This criterion is based on the idea that two service units considered by citizens to be equivalent can however be produced at different costs because citizens do not check completely the production process of the services. The unit cost criterion is no longer then relevant and has to be replaced by a criterion corresponding to the usefulness of the non-market services for society.

As the outcome criterion often seems more relevant, a large amount of work has been completed to develop methods based on this criterion and research to improve them continues. In practice, such methods often result in the introduction to the volume calculation of correction coefficients applied to quantities; they take then the name of methods with explicit correction for quality.

10.31  Value added, the balancing item in the production account, is the only balancing item to form part of the integrated system of price and volume indices. The very special characteristics of this item must, however, be emphasised, as must the significance of its related volume and price indices.

10.32  Definition: value added in volume terms is defined as the difference between output in volume terms and intermediate consumption in volume terms.

10.33  In some cases, where the statistical data remain incomplete or insufficiently reliable, it may be necessary to use a single indicator. If there are good data on current added at current prices, one alternative to double deflation is to deflate current value added directly by a price index for output. This implies the assumption that prices for intermediate consumption change at the same rate as for output. Another possible procedure is to extrapolate current added in the base year by a volume index for output. This volume index can be calculated either directly from quantity data or by deflating the current value of output by an appropriate price index. This method in fact assumes that the volume changes are the same for intermediate consumption.

10.34  By their very nature, therefore, the indices of volume and price for value added are different from the corresponding indices for the flows of goods and services.

10.35  Although essentially limited to transactions involving goods and services, the integrated system of price and volume indices does not exclude the possibility of calculating measures of changes in price and volume for certain other transactions.

10.36  The possibility mentioned above exists, in particular, in the case of taxes and subsidies directly linked to the quantity or value of the goods and services which are the subject of certain transactions. In the supply and use tables, the values of those taxes and subsidies are shown explicitly. By applying the rules described below, it is possible to obtain price and volume measures for the categories of taxes and subsidies which are recorded in the goods and services accounts, namely:

1. taxes on products, excluding VAT (D.212 and D.214);
2. subsidies on products (D.31);
3. VAT on products (D.211).

10.37  The simplest case is that of taxes which represent a fixed amount per unit of quantity of the product which is the subject of the transaction. The value of the revenue from such a tax depends upon:

1. the quantity of products involved in the transaction;
2. the amount levied per unit, i.e. the taxation price.

The breakdown of the value change into its two components presents virtually no difficulties. The variation in volume is determined by the change in the quantities of products taxed; the price variation corresponds to the change in the amount levied per unit, i.e. to the change in the taxation price.

10.38  A more frequent case is that in which the tax represents a certain percentage of the value of the transaction. The value of the revenue from such a tax then depends upon:

1. the quantity of products involved in the transaction;
2. the price of the products involved in the transaction;
3. the tax rate (as a percentage).

The taxation price is then obtained by applying the rate to the price of the product. The change in value of the revenue from a tax of this type can also be divided into a volume change, determined by the change in the quantities of products taxed, and a price change corresponding to the change in the taxation price (b x c).

10.39  The amount of taxes on products, excluding VAT (D.212 and D.214) is measured in terms of volume by applying to the quantities of products produced or imported the taxation prices of the base year or by applying to the value of output or imports, revalued at the prices of the base year, the tax rates of the base year. Attention has to be paid to the fact that taxation prices may differ among different uses. This is taken into account in the supply and use tables.

10.40  Similarly, the amount of subsidies on products (D.31) is measured in terms of volume by applying to the quantities of products produced or imported the subsidy prices of the base-year or by applying to the value of output or imports, revalued at the prices of the base-year, the rates of subsidy of the base-year, taking into account different subsidy prices for different uses.

10.41  VAT on products (D.211) is, both for the whole economy and for individual industries and other users, calculated on a net basis and refers only to non-deductible VAT. This is defined as the difference between VAT invoiced on the products and VAT deductible by the users of these products. Alternatively, it is also possible to define VAT on products as the sum of all non-deductible amounts which have to be paid by users.

1. either because of a change in the right to deduct VAT, resulting from a change in tax laws or regulations, taking effect with or without a time lag;
2. or because of changes in the pattern of uses of the product (e.g. increase in the proportion of uses on which VAT may be deducted).

A change in the amount of deductible VAT resulting from a change in the right to deduct VAT will, by the method described, be treated as a change in the taxation price, as will a change in the rate of invoiced VAT.

10.42  The treatment of other taxes (D.29) and subsidies (D.39) on production raises a particular difficulty, to the extent that, by definition, it is not possible to assign them directly to units which are produced. In the case of non-market services, this difficulty is compounded by the fact that they are used only when it is not possible to define units of quantity. However, it is generally possible to get around this difficulty by defining other taxes and subsidies on production in volume terms, by the amount to which they would have risen if there had been no change in the tax rules and prices as a whole in relation to the previous year. For example, taxes on property or the use of an asset can be evaluated in volume terms by applying to the current period the rules and the price of assets of the previous year.

10.43  The calculation of volume measures of the consumption of fixed capital poses few problems when good data on the composition of the stock of fixed capital goods are available. The perpetual inventory method, used by most countries, already implies, for the estimation of the consumption of fixed capital at current prices, the need to firstly carry out a calculation of the stock of fixed capital goods in volume terms. To go from a valuation at historic cost to one at replacement cost, it is necessary firstly to value capital goods acquired over a number of different periods on a homogeneous basis, i.e. base-year prices. The price and volume indices derived in the process can therefore be used to calculate the value of the consumption of fixed capital in volume terms and the associated price index.

10.44  For the purpose of measuring the volume of input from employee labour, the quantity unit for compensation of employees may be considered to be an hour's work of a given type and level of skill. As with goods and services, different qualities of work must be recognised and quantity relatives calculated for each separate type of work. The price associated with each type of work is the compensation paid per hour, which may vary, of course, between different types of work. A volume measure of work done may be calculated as a weighted average of the quantity relatives for different kinds of work, weighted by the values of compensation of employees in the previous year or fixed base year. Alternatively, a wage rate index may be calculated for work by calculating a weighted average of the proportionate changes in hourly rates of compensation for different types of work, again using compensation of employees as weights. If a Laspeyres type of volume index is calculated indirectly by deflating the changes in compensation of employees at current values by an index of the average change in hourly compensation, the latter should be a Paasche-type index.

10.45  Volumes at the prices of the previous year are needed both for stocks of produced fixed assets and for inventories. For the former, such data as are necessary for the calculation of capital output ratios are available if use is made of the perpetual inventory method. In other cases information on the values of stocks of assets may be collected from producers and deflation made by the price indices used for fixed capital formation, taking into account the age structure of stocks.

10.46  It is generally not possible to divide income flows into a price and a quantity component and for this reason price and volume measures cannot be defined in the same way as for the flows and stocks of products. Income flows can be measured in real terms only if one chooses some selected basket of goods and services on which the income is typically spent and uses the price index for this basket as a deflator of current incomes. The choice is always arbitrary in the sense that income is seldom spent specifically for purchases during the period in question. Some of it may be saved for purchases in later periods or, alternatively, the purchases during the period may be partly financed from savings made earlier.

10.47  Gross domestic product at previous year prices measures the total production (less the intermediate consumption) in volume terms for the total economy. The total real income of residents is influenced not only by this volume of production but also by the rate at which exports can be traded against imports from the rest of the world. If the terms of trade improve, fewer exports are needed to pay for a given volume of imports, so that at a given level of domestic production goods and services can be reallocated from exports to consumption or capital formation.

10.48  The fact that countries have different price levels and currencies poses a challenge to interspatial comparisons of prices and volumes. Nominal exchange rates are not suitable conversion factors in such comparisons, because they do not adequately reflect price level differences, and because they are not sufficiently stable over time.

10.49  Instead, purchasing power parities (PPPs) are applied. A PPP is defined as the number of units of country B's currency that is needed in country B in order to purchase the same quantity of goods and services that one unit of country A's currency will purchase in country A. PPPs can thus be interpreted as the exchange rate of an artificial currency commonly referred to as the purchasing power standard (PPS). If the expenditures of countries A and B expressed in national currencies are converted into PPS, the resulting figures are expressed in the same price level and the same currency, allowing a meaningful comparison of volumes.

10.50  PPPs for market goods and services are based on international price surveys. Such price surveys are carried out simultaneously in all participating countries, based on a common product sample. The sample items are clearly specified in terms of their technical characteristics, as well as other variables that are assumed to influence the price, like installation costs and the terms of sale. While priority is given to the comparability of the sample items, this must nevertheless be weighted against their representativity in national markets. The product sample should ideally be equally representative in all participating countries.

10.51  For non-market services, interspatial comparisons face the same problem as intertemporal ones, since no market prices exist in either dimension. Traditionally, an input approach (or an input cost approach) has been applied, under the assumption that output equals the sum of inputs. This approach, which implies direct or indirect volume comparisons of inputs, fails to take differences in productivity into account. For this reason, as for intertemporal comparisons, methods are preferred which focus either on the direct measurement of output or on output prices which are subsequently used to deflate expenditure, at least for individual services such as education and health.

10.52  In the calculation of PPPs, the same index number formulae are applied as in the calculation of temporal indices. In a bilateral context involving two countries, A and B, either country can be used to give the weights. Viewed from the angle of country A, a Laspeyres-type index with weights from country A can be calculated as well as a Paasche-type index using weights from country B. However, if the two economies are structurally different, the spread between these two indices may be quite large, and the end result would be heavily influenced by the choice of index. In binary comparisons, it is thus preferable to apply the average of the two, that is, a Fisher index.

10.53  Explicit numerical weights are usually not available at the level of individual sample items. Therefore, a form of implicit weighting is applied, based on whether countries regard a particular item as representative of the domestic consumption pattern or not. The lowest level of aggregation for which numerical weights are available, is referred to as the basic heading (BH) level.

10.54  Transitivity implies that the direct PPP between countries A and C is equal to the indirect PPP derived by multiplying the direct PPP between countries A and B (or any other third country) and the direct PPP between countries B and C. The Fisher PPPs at BH level are not transitive, but it is possible to derive from them a set of transitive PPPs that resemble the original Fisher indices, using the criterion of least squares for this purpose. Applying the so-called Éltetö-Köves-Szulc (EKS) formula minimises the deviations between the original Fisher indices and produces a complete set of transitive PPPs at BH level.

10.55  The resulting set of transitive PPPs for all countries and all BHs are aggregated up to the level of total GDP using expenditures from national accounts as weights. The aggregate PPPs at the level of GDP or any other category can be applied in, for instance, the calculation of real expenditures and spatial volume indices. A PPP divided by the nominal exchange rate between two countries produces a price level index (PLI), that can be used in analyses of countries' comparative price levels.

10.56  The European Commission (Eurostat) is responsible for calculating PPPs for the Member States in accordance with Regulation (EC) No 1445/2007 [2]

Regulation (EC) No 1445/2007 of the European Parliament and of the Council of 11 December 2007 establishing common rules for the provision of basic information on Purchasing Power Parities and for their calculation and dissemination

. In practice, these PPP calculations are embedded in a wider PPP program coordinated jointly by Eurostat and OECD. The detailed methods used in the program are described in the Eurostat-OECD Methodological manual on purchasing power parities [3]

Eurostat-OECD Methodological Manual on Purchasing Power Parities

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