Macro/ch2
1
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
Macro/ch2
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)
Macro/ch2
3
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 (GDP
1
-
GDP
0
)/GDP
0
•
Unemployment rate
measures proportion of people without jobs
•
Inflation rate
measures the overall increase in prices
Macro/ch2
4
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
)
Macro/ch2
5
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.
Macro/ch2
6
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
Macro/ch2
7
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
Macro/ch2
8
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
Macro/ch2
9
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).
Let’s 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.
Macro/ch2
10
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
Macro/ch2
11
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
Macro/ch2
12
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
)
Macro/ch2
13
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 ).
Macro/ch2
14
The $ looses its value
-
it
depreciates
-
it shrinks
GDP in 2000
1950 $
2000 $
GDP = 5
GDP = 10
Macro/ch2
15
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!
Macro/ch2
16
•
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.
Macro/ch2
17
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
Macro/ch2
18
Nominal GDP Growth
P
0
Q
0
P
0
Q
0
P
1
Q
1
P
1
Q
1
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:
Macro/ch2
19
Real growth versus inflation
Real growth
%∆Q
Inflation
%∆P
BOOKS
5%
10%
TV
10%
20%
For the
economy
?
?
Macro/ch2
20
Base: earlier year
-
Laspeyres
P
0
Q
0
P
0
Q
0
P
0
Q
1
P
0
Q
1
Books
$1
1000
$1000
$1
1050
$1050
TV
$500
10
$5000
$500
11
$5500
Real
GDP
$6000
$6550
Rate of growth of real GDP:
Macro/ch2
21
Base: latter year
-
Paasche
P
1
Q
0
P
1
Q
0
P
1
Q
1
P
1
Q
1
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:
Macro/ch2
22
Chained index*: average price
P
aver
Q
0
P
aver
Q
0
P
aver
Q
1
P
aver
Q
1
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
Macro/ch2
23
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 base=1995)
Macro/ch2
24
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
Macro/ch2
25
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
Macro/ch2
26
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%
Macro/ch2
27
Unemployment & output: Okun’s law
-
2
-
1
0
1
2
3
0
1
2
-
1
-
2
∆ in u
GDP growth
*
*
*
*
*
*
*
*
*
*
This is a purely empirical relation showing that high increases in
unemployment correspond to low output growth
%∆ in GDP = 3%
-
2* ∆ in u
Macro/ch2
28
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
Macro/ch2
29
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%
Macro/ch2
30
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
Macro/ch2
31
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.
Macro/ch2
32
Inflation and unemployment:
the Phillips curve
∆ in π
u
4
6
8
10
0
-
1
-
2
-
3
-
4
4
3
2
1
*
*
*
*
*
*
*
*
*
*
It shows a negative relation
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