What is macroeconomics?

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What is macroeconomics?

• Studies interaction between main aggregate
  economic variables
• 1. Output
• 2. Employment
• 3. Inflation
• Studies impact of main government policies
• 1. Fiscal policy
• 2. Monetary policy
• Simplifies and summarizes these interactions with
  models of the economy

2
Difference with microeconomics

• Micro studies supply and demand relations in a
  specific market, production at the level of the
  firm, consumption at the level of the consumer
  etc
• Micro make use of relative prices and not price
  levels
• Micro is based on premises which are generally
  accepted while macro evolves overtime and its
  premises depend on schools of thought (e.g.
  Keynesian versus classical assumptions)

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The 3 main measures of macro performance

• Aggregate output
• measures total production in the economy
• Total Gross Domestic Product - GDP
• GDP per capita (GDP/number of inhabitants)
• Rate of growth of GDP or (GDP1 -GDP0)/GDP0
• Unemployment rate
• measures proportion of people without jobs
• Inflation rate
• measures the overall increase in prices

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Aggregate output GDP

• GDP is the value of the final goods and services
  produced in the economy during a given period
• GDP is the sum of the value added in the economy
  during a given period
• GDP is the sum of income earned in the economy
  during a given period
• GDP is a flow (not a stock)

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Calculating GDP

• Example
• Mine extracts iron ore.
• Steel mill buys - 10 worth - of iron ore that it
  used to produce steel. It then sell the steel for
  25 to a cutlery factory.
• Cutlery manufacturer transforms the steel - 25
  worth - into a cutlery set sold directly to the
  consumer (at a factory store) for 35.

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Value of final goods to avoid double counting

• Value of final good 35
• Including the value of the iron ore or of the
  steel produced would be double counting.
• Why? Because the iron ore is included in the
  value of the steel and the steel is included in
  the value of the cutlery set

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Value added approach

• Definition Value added value of sale minus
  value of purchased inputs (the intermediate goods
  used in production)
• Mine (no purchased input) VA 10
• Steel mill VA 25 - 10 15
• Cutlery factory VA 35 - 25 10
• Total value added 35

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Income approach

• Another interpretation of the value added
• The value added is equal to all the production
  costs incurred by the firm - other than the
  purchase of material.
• so what is left?
• the payments to owners of the factors of
  production.
• to the owners of land i.e. the rent
• to the owners of capital i.e. the
  interest
• to the workers i.e. their wages
• and to the proprietors/entrepreneurs i.e. their
  profit

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• The value added corresponds to the income of
  these 4 groups (if a tax is paid to the
  government, it should also be taken into
  account).
• Lets now set up a table showing the rent, the
  interest, the wages and the profit in each of the
  3 firms and illustrating how the sum of these
  costs in equals the value added by each firm.

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Income approach
Mine Steel mill Cutlery factory Total
Rent 1 3 1 5
Interest 2 8 2 12
Wages 5 3 4 12
Profit 2 1 3 6
VA 10 15 10 35
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Nominal and real GDP

• Some data on nominal GDP

1960 1994 2000
Nominal GDP in billion 526 6,736 9,872
Growth of nominal GDP since 1960 x13 x16

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• Nominal GDP is GDP measured in in the specific
  year quoted.
• Do these huge increases represent real growth (or
  growth in the quantity of goods produced)?
• Remember that GDP is calculated as the sum of the
  value of the various goods.
• Value quantity price
• so these large rates of growth include
• growth in quantity ( or real growth )
• as well as
• growth in price ( or inflation )

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Nominal GDP

• Definition sum of value of goods and services
  produced during the year at current prices
• Nominal GDP increases overtime because
• 1. quantity of goods and services produced
  increases
• 2. their price also increases (inflation)
• The 2nd cause does not correspond to real growth
  but to a change in the measuring yardstick, the
  dollar (the looses its value - it depreciates -
  it shrinks ).

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The looses its value - it depreciates - it
shrinks
GDP in 2000
GDP 5
1950
2000
GDP 10
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How to calculate real GDP?

• Nominal GDP is calculated every year.
• But these yearly data do not allow us to judge by
  how much the economy has actually grown, in terms
  of quantity of goods and services produced.
• So we need to calculate real GDP to appraise the
  real growth of the economy over the years.
• Unfortunately there are more than one way to do
  it!

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• How do we neutralize the effect of the changes in
  price in order to only retain the effect of the
  changes in quantity?
• The solution is to measure GDP in 2 different
  years with the same set of prices. Then the
  difference in the two measures of GDP will only
  include the change in quantity.
• Which set of prices should we use?
• Depending of the set of prices chosen we will get
  slightly different results.

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Calculation of real GDP the index problem

• As price increases are not homogeneous, the
  conversion from nominal to real GDP will yield
  different results according to the base year used
  
• First year - Laspeyres Index
• Last year - Paasche Index
• This problem can be circumvented by using a
  chained index
• i.e. not the same for every good

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Nominal GDP Growth
P0 Q0 P0Q0 P1 Q1 P1Q1
Books 1 1000 1000 1.1 1050 1155
TV 500 10 5000 600 11 6600
Nominal GDP 6000 7755
Rate of growth of nominal GDP
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Real growth versus inflation
Real growth ?Q Inflation ?P
BOOKS 5 10
TV 10 20
For the economy ? ?
20
Base earlier year - Laspeyres
P0 Q0 P0Q0 P0 Q1 P0Q1
Books 1 1000 1000 1 1050 1050
TV 500 10 5000 500 11 5500
Real GDP 6000 6550
Rate of growth of real GDP
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Base latter year - Paasche
P1 Q0 P1Q0 P1 Q1 P1Q1
Books 1.1 1000 1100 1.1 1050 1155
TV 600 10 6000 600 11 6600
Real GDP 7100 7755
Rate of growth of real GDP
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Chained index average price
Paver Q0 PaverQ0 Paver Q1 PaverQ1
Books 1.05 1000 1050 1.05 1050 1102.5
TV 550 10 5500 550 11 6050
Real GDP 6550 7152.5
Rate of growth of real GDP
Approximation for actual method
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Terminology

• Nominal GDP or Y
• GDP
• GDP in current dollars
• Real GDP or Y
• GDP in terms of goods
• GDP in constant dollars
• GDP adjusted for inflation
• GDP in 1995 dollar (if base1995)

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Unemployment rate u

• L N U
• L is labor force
• N is number of employed
• U is number of unemployed
• u U/L
• u is rate of unemployment
• Data gathered by Bureau of Labor Statistics (BLS)
• Current Population Survey

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Additional employment statistics

• A L NL
• A is adult population
• NL is not in the labor force
• Discouraged workers (not looking for job anymore)
• Retirees, home makers etc.
• Participation rate L/A

• When u is high, people stop looking for jobs and
  of discouraged workers (in NL) increases, hence
  the participation rate drops

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Labor statistics problem

• In a given month in the US,
• 100 million people are working N 100
• 10 million are not working but are looking for
  work U 10
• and 20 million are not working and have given
  up looking for work DW 20.
• Calculate the labor force L N U 100 10
  110
• Calculate the official unemployment rate u
  U/L 10/110 9.1
• If an additional 40 million adults are not
  working for various other reasons beside being
  discouraged (retired, homemaker etc.)
• Calculate the adult population A L DW 40
  170
• Calculate the participation rate PR L/A
  110/170 65

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Unemployment output Okuns law
? in u
? in GDP 3 - 2 ? in u
2


1


0
GDP growth
-2 -1 0 1 2 3


-1




-2
This is a purely empirical relation showing that
high increases in unemployment correspond to low
output growth
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The inflation rate

• Definition rate at which the price level
  increases
• Measured
• By GDP deflator nominal GDP / real GDP
• By CPI or Consumer Price Index
• GDP deflator can be calculated by methods similar
  to those developed for the calculation of real GDP

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Calculation of GDP deflator

• Using data from previous example

Year 0 (as base) Year 1
Nominal 6000 7755
Real 6000 6550
GDP Deflator 1 1.18
That is the rate of inflation is 18
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CPI or Consumer Price Index

• Based on cost in of a fixed basket of goods and
  services consumed by an average urban consumer
  
• Monthly indicator existing since 1917 (BLS)
• Data gathered in 85 cities and 22,000 retail
  stores
• Revised every 10 years as consumption changes

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Difference between GDP deflator and CPI

• Deflator based on all the goods and services
  produced in the economy so it includes
  government, investment and exports.
• CPI is based on a fixed subset of consumption
  goods and services so it includes imports.
• The set of goods and services on which the
  deflator is based changes from year to year while
  the set included in the CPI is adjusted every 10
  years.

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Inflation and unemployment the Phillips curve
? in p
It shows a negative relation
4 3 2 1





0 -1 -2 -3 -4





u
4 6 8 10