Introduction to Terms of Trade

It is not possible to divide income and financial flows into a price and a quantity component directly, as no meaningful price and volume measures can be defined. However, income flows can be expressed in terms of the purchasing power over some selected basket of goods and services. By comparing nominal income deflated with the price index for a selected basket of goods and services with the actual/nominal income in the base year, one can look at the increase or decrease in the income's real purchasing power. In general, there is often no obvious choice of basket, the choice depends on the particular analytical use of the measure. Because of this, there has been some reluctance to show real income measures in the national accounts in many countries because the producers would leave the choice of appropriate basket to the users. Consequently 68SNA did not contain any recommendations on real income. Since not all users have the opportunity, or the expertise to calculate the real income measures which may best suit their needs, and because real income may be an analytical useful concept, 93SNA contains a discussion of alternative definitions and measures of real income.

For most purposes it seems naturally to use as a numeraire a basket of goods and services on which most of the income is most likely to be spent. Thus, for household income it seems naturally to use the CPI or the implicit households’ consumption expenditure deflator in the national accounts as a numeraire. Similarly, for the total economy it seems most naturally to use the implicit total domestic final expenditure deflator, or the total final expenditure deflator, as a numeraire.