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Chapter 1 Introduction To Macroeconomics

Δ.1.1 What Is Macroeconomics?
 Macroeconomics : the study of collections of people and firms and how their
interactions through markets determine the overall economic activity in a country
or region

 Macro combines these models with real- world phenomena — history, politics,
and economic policy.

 Consider these questions:

 How do we understand the global financial crisis, the Great Recession,

and the European debt crisis of recent years? As shown in Figure 1.2, this
latest recession has seen the largest sustained decline in employment in
the United States in many decades.

 What determines the rate of inflation; that is, what determines how
rapidly prices are increasing in an economy? Why was inflation so high in
much of the world in the 1970s, and why has it fallen so dramatically in
many of the richest countries since the early 1980s?

 Budget deficits result when the government borrows money to finance its
spending. Trade deficits result when one economy borrows from another.
Why would an economy run a high budget deficit or a high trade deficit,
or both?
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Δ.1.2 How Macroeconomics Studies Key Questions

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1. Document The Fact

– Gather economic data
 Make precise , quantitative statements
2. Develop A Model
– Models allow abstracting from infinite no. of forces in real world to focus on the
most relevant ones
– Abstract model is an unrealistic picture
– All models have input set of parameters and exogenous variables.
 Parameter: input generally fixed over time, except when model builder
experiment with it.
 Exogenous Variables: input that is allowed to change over time, but in a
way that is completely determined ahead of time by the model builder.

– The model operates on parameters & exogenous variables -> endogenous

variables.
 E.g Equation describing labor supply and an equation describing
labor demand = math model of labor market

3. Comparision Of Prediction With Original Fact:

– How well our model helps us understand the facts we began with.
– The model should also get the quantitative predictions right.

4. Make Predictions:
- Model builder is free to change the underlying parameters -> analyze how this
change affects the endogenous variables.
- Explicit mathematical model make quantitative predictions-> compared with real
evidence -> judge the validity of the model -> analyze particular policy changes.
 E.g How effective was the $800 billion fiscal stimulus program approved by the U.S.
government during the global financial crisis in January 2008? The unemployment
rate during the next 2 years rose by substantially more than macroeconomic
forecasters had predicted. Was this because the fiscal stimulus implied higher future
taxes that made businesses reluctant to hire? Or was it because the macroeconomic
shocks of the period were more severe than forecasters realized? Ideally, economists
would observe two parallel universes, one in which the fiscal stimulus plan is
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implemented and another that is identical except that the plan is not implemented.
The frequent absence of this kind of evidence makes it remarkably difficult to answer
many such policy questions with extreme confidence.

 Notice that in Figure 1.7 two lines are plotted: the blue line is actual per capita GDP, or
output, while the orange line, a “smoothed” version of the solid line, is called potential
output. Potential output measures the way per capita GDP would evolve if prices were
completely flexible and resources were fully employed. The second important feature of
the figure is that actual output deviates from potential output. Other than the Great
Depression of the 1930s, these deviations are hard to see, but they are still economically
important. For example, in 1982, the U.S. economy suffered one of the largest recessions
of the post–World War II era, and actual output was about 5 percent less than potential
output. In today’s prices, this gap was roughly $1,500 per person, or $6,000 for a typical
family of four, so this recession represented a large cost in terms of lost income.
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Chapter 2 Measuring The Macroeconomics

Δ.2.1 Introduction
 National income accounting provides a systematic method for aggregating the
production of cars, computers, health care, and music into a single measure of
overall economic activity.
 It relates this measure of aggregate production to the total amount of
income earned by every person in the economy and to all the spending that
occurs.
 In the best accounting relations in economics, total production equals total
income equals total spending.
Δ.2.2 Measuring The State Of Economy
 Gross domestic product: market value of the final goods and services
produced in an economy over a certain period.

Product=Expenditure=Income
- Suppose the economy consists of only a single family farm with a small fruit
stand in the front yard. Homer and Marge, grow tangerines on the land, hire some
workers to help them with the harvest, and then sell the tangerines at the fruit
stand.
 GDP in this simple economy is the total number of tangerines Homer and
Marge produce in a year. This is the production measure of GDP, and we
could compute it by following the farmworkers through the orchard and
counting the tangerines as they get picked.
 Alternative way to measure this GDP is by focusing on sales at the fruit stand.
Consumers visit the buy tangerines, and the total purchases = expenditure
approach to measuring GDP. As long as all the tangerines that are picked end
up being sold, these two measures will be equal.
 Income approach to measuring GDP adds up all the income earned in the
economy. On the farm, all production gets paid out to someone as income —
either to the workers as wages or to Homer and Marge as “profits” so the
production measure of GDP must also be equal to the income measure.

 Economic profits :above-normal returns associated with prices that exceed those
that prevail under perfect competition.
 Unless there is some market power by which firms charge prices above
marginal cost, economic profits are zero.

Expenditure Approach To GDP

 The National Income Identity Y = C + I + G + NX

 Y = GDP (in dollars),

 C = consumption,
 I = investment,
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 G = government purchases,
 NX ( net exports )= exports – imports

 Consumption Expenditures: motor vehicles, food, housing services, and

medical care,
 Investment Expenditure: Purchases by businesses of structures like office
buildings and equipment such as computers and machine tools.
 Government Purchases: expenditures on public schools, highways, government-
funded research, and national defense. Also “transfer” payments (like Social
Security and Medicare) and interest payments on any outstanding government
debt
 Net Exports: trade deficit=imports > exports
 If the government decides to reduce its share in the economy, more is left over for
private consumption.
 Rising trade deficit should make us wary. A trade deficit is basically a way to
borrow goods and services from another economy.
 The only way they will agree to do this is if we promise to repay the
“loan” in the future. This repayment will show up in the form of future
trade surplus -> less GDP available for consumption, investment, and
government purchases.
Income Approach To GDP
 For every dollar of product sold there is a dollar of income earned.
 GDP is equal to the value of all goods and services produced in the
economy, but also the sum of all income earned in the economy.
 Capital: inputs into production other than labor that are not completely used
up in the production process.
 E.g factory or office building and equipment like computers or
copying machines
 Investment = way a firm increases its stock of capital.
 E.g steel in an automotive factory is not capital, but an intermediate
input that is used up in production
 When Homer and Marge run their fruit stand for a year, the shelving, light
fixtures, and wooden structure all endure some wear and tear. The wear and
tear is called depreciation. Some of their income is implicitly a compensation
for this wear and tear — that is, for the depreciation of the farm’s capital.
 The presence of this depreciation accounts for the label “gross domestic
product”; if we subtract out the depreciation, then the remainder is referred to
as “net domestic product.”
 If assign all income to either labor or capital:
 The fraction of GDP earned by labor is approximately two-thirds->1/3
income= capital .Labor share fluctuates very little (65 -70 percent of
GDP)-> indicates there is no general trend to capital’s share or labor’s
share of income (not the case that corporations or shareholders are getting
rich at the expense of labor).
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Production Approach To GDP

 When GDP = value of goods and services-> there is no double counting
 E.g if a steel company produces $10 million worth of steel that is then
used by an automobile company to make $100 million worth of trucks,
the value of the steel is not counted twice. The GDP goes up by $100
million.
 Only the final sale of goods and services counting toward GDP.
 Producer creates an amount of GDP equal to the amount of value that is
added during production.
 Value added = subtracting the value of intermediate products (like steel or
electricity; $10 million in our example) from the revenue generated by each
producer.
 The steel producer generates $10 million of GDP, while the automobile
producer generates $90 million ($100 million - $10 million), for a total
increment once again of $100 million.
 GDP only counts new production.
 E.g, if a construction company builds a new house and sells it for
$200,000, this amount counts toward GDP. But suppose a used-car
dealer buys a 2004 minivan for $17,000 and then sells it the next day
to a family for $20,000; by how much does GDP change? The full
$20,000 does not count toward this year’s GDP: the car already
existed and does not represent new production. However, the “profit”
of $3,000 earned by the dealer does count toward GDP: the product is
the service of finding a match for minivan and family.

What Is Included in GDP and What’s Not?

 GDP includes only goods and services that transact in markets.
 Only the purchase of the ingredients contributes to GDP.
 GDP omits people’s health in a nation
 GDP is that it doesn’t include changes in environmental resources.
 When non-renewable natural resources like oil and natural gas are extracted, GDP
goes up because of the productive effort spent turning the reserves into
products, but there is no deduction from GDP associated with the reduction of oil
and natural gas reserves.

Δ.2.3 Measuring Changes Over Time

 Economists use the word “nominal” to refer to a measure like GDP when prices
and quantities have not been separated out and use “real” to refer only to the
actual quantity of goods and services.
 Nominal GDP = Price Level x Real GDP
 E.g. If an economy produces 37 cell phones and nothing else, and if
the price of each is $100, then nominal GDP would equal $3,700,
while real GDP would equal 37 cell phones.
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 Change in prices=change in nominal GDP.

 We measure nominal GDP in current dollars and real variables.

Quantity Indexes: Laspeyres, Passche and Chain Weighting

 Laspeyres Index: Computing the change in real GDP with the initial prices.
 Paasche index: Method that uses the final prices.
 Give different answers, and the size of the difference depends on the
extent to which relative prices have changed.
 Chain Weighting (Fisher Index): First compute the Laspeyres and Paasche
indexes, and then calculate the average of the two growth rates.
 Chain weighting gives us an average of these two extremes and in general
provides a more accurate view of how standards of living change over
time.
 Real chain-weighted GDP is computed by applying the Fisher index on a
year-by-year basis.

Price Indexes and Inflation

 Recall: Nominal GDP = Price Level x Real GDP
 In the national accounts, the price level that satisfies this equation is called the
GDP deflator.
 Real GDP can be computed by “deflating” nominal GDP; that is, by
dividing by the price level.

 Inflation Rate: Percentage change in the price level.

 The main downside to chain weighting in national accounts: Recall that the sum
of nominal consumption, investment, government purchases, and net exports
is = nominal GDP.
 Unfortunately, this is not true for the chain-weighted numbers: the sum of
real chain-weighted consumption, investment, government purchases, and
net exports does not generally equal real chain-weighted GDP. (The
reason is that different prices are used in constructing the different
components.)
 If you are interested in particular shares, (share of investment in GD-> look at
the ratio of nominal variables, since the nominal shares will add up.
 If you are interested in real rates of economic growth-> use the chain-weighted
real measures.

Δ.2.4. Comparing Economic Performances

 Exchange rate: Price at which one exchange of currency occurs.

An Example
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Chapter 3 An Overview Of Long-Run Economic Growth

Δ.3.2 Growth Over The Very Long Run

 Sustained growth emerges in different places at different times.

 Growth first starts to appear in the United Kingdom and then in the United
States.
 Standards of living in Brazil and Japan begin to rise mainly in the past century or
so, and in China, only during the past several decades.
 An important result of these differences in timing is that living standards around
the world today vary dramatically
 In the past three centuries, standards of
 Living have diverged dramatically, a phenomenon that has been called the Great
Divergence.
\
Δ.3.3. Modern Economic Growth
The Definition Of Economic Growth
 Slope of the income series shown in Figure 3.2 has been rising over time: our
incomes are rising by an ever-increasing amount each year.
 Income changes are roughly proportional to the level of per capita income
at any particular time.
 y2016 - y2015 = g x y2015 -> g=0.02
 Change in per capita income between 2015 and 2016 is roughly
proportional to the level of per capita income in 2015, where the factor of
proportionality is 2%.
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 Percentage change in per capita income =g, and it is this percentage

change that we call a growth rate.
 Growth Rate = (yt+1-yt)/yt
 Level Of Per Capital Income= yt+1=yt(1+g)

 Constant Growth Rule : yt=y0(1+g)t

Rule Of 70 and Ratio Scale

 Rule of 70: if yt grows at a rate of g percent per year, then the number of years it
takes yt to double is approximately equal to 70/g.
 E.g. if yt grows at 2 percent per year, then it doubles about every 70/2
= 35 years.
 If a country’s income grows at 1 percent per year, then it takes about 70 years for
income to double.
 If growth is slightly faster at 5 percent per year, then income doubles
every 14 (70/5) years.
 The time it takes for income to double depends only on growth rate, not current
level of income.
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 Squishing the vertical axis this way creates a ratio scale:4 a plot where equally
spaced tick marks on the vertical axis are labeled consecutively with numbers
that exhibit a constant ratio.

U.S GDP On A Ratio Scale

 Growth rate in the first half of the sample was slightly lower than this.
 For example, the slope between 1870 and 1929 is slightly lower than that
of the 2.0 percent line, while the slope between 1950 and 2012 is slightly
higher.

Calculating Growth Rate

 If the data for every year are available ->compute the percentage change across
each annual period-> measure growth.
 Given data only for the start and end of this series:
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 For a quantity growing at a constant rate, the level in year t is given by yt

= y0(1+g)t -> given values of initial & final values :rearrange the equation
and then take the tth root of the ratio of the two incomes,

 Average Annual Growth: g=(yt/y0)1/t-1

Δ.3.4. Modern Growth Around The World

 Convergence: The process of per capita income levels moving closer together
over time.
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Some Useful Properties Of Growth Rates

Δ.3.5. The Costs Of Economic Growth

 Pollution, the depletion of natural resources, and global warming.
 Increased income inequality — certainly across countries and perhaps even within
countries.
 Technological advances may also lead to the loss of certain jobs and industries.
 E.g. automobiles decimated the horse-and-buggy industry;
 Environmental economists have documented an inverse-U shape for this
relationship. Pollution grows worse initially as an economy develops, but it often
gets better eventually.
 E.g. Smog levels in Los Angeles are substantially less today than they
were 30 years ago; one reason may be that cars in California produce
noxious emissions that are only 5 percent of their levels in the mid-
1970s.

Chapter 4 A Model Of Production

Δ.4.2. A Model Of Production

 Assume certain number of people available to make ice cream.=L (for “labor”)
and certain number of ice cream machines, given by K (for “capital”).
 A production function tells us how much output Y can be produced if L workers
are combined with K machines.
