Chapter 1: Introduction to Macroeconomics

This course is designed to introduce you to the most influential and compelling theories devised by macroeconomists in order to explain issues related to the determination of output, unemployment and inflation.

Macroeconomics is the art of imagining a simplified world, a macroeconomic model, in which the interaction between households, firms and policy makers determines the value of aggregate production, the total number of people working in the economy, and the general price level. The ultimate objective of this exercise of imagination is to examine how and to what extent this simplified world might help to answer the following five fundamental macroeconomic questions about the real world:

1. Why does output grow over very long periods of time?
2. Why is output growth not steady, but varies from year to year?
3. What determines the rate of unemployment?
4. Why do prices increase over time?
5. What should policy makers do to boost output growth, reduce unemployment and control inflation?

Dornbusch R., Fischer, S., Startz, R., Macroeconomics (9th edition, international), McGraw-Hill, 2004

"The level of aggregate supply is the amount of output the economy can produce given the resources and technology available.

The level of aggregate demand is the total demand for goods [and services] to consume, for new investment, for goods purchased by the government, and for net goods to be ex[ported abroad.

The aggregate supply (AS) curve depicts, for each given price level, the quantity of output firms are willing to supply.

The aggregate demand (AD) curve depicts, for each given price level, the level of output which the goods markets and money markets are simultaneously in equilibrium.

In the long-run the aggregate supply curve is vertical.

It follows that *in the long-run* output is determined by aggregate supply alone and prices are determined by both aggregate supply and aggregate demand."


"Very high inflation rates - that is episodes with rapid increases in the overall price level - are always due to changes in aggregate demand. p8

.. *in the short run* output is determined by aggregate demand alone and prices are unaffected by the level of output." p9

[Aggregate supply in the very long-run is vertical and cannot change. Any change is due to shifts e.g., technology. In the very short-run it is horizontal, which means it will change entirely according to demand. In the medium run macroeconomics debates on how steep it is - surely this varies by product.]

".. prices usually adjust pretty slowly... changes in aggregate demand give a good, although certainly not perfect, account of the behavior of the economy. The speed of price adjustment is summarized in the *Phillips curve*" p10 [unemploymenmt and change in inflation,]

"The *growth rate* of the economy is the rate at which the gross domestic product (GDP) is increasing" p11

"The trend path of GDP is the path GDP would take if factors of production were fully employed" p14 [no, that would mean that GDP could not be higher than the trend path].

"The output gap measures the gap between actual output and the output the economy could produce at full employment given the existing resources. Full employment output is also called *potential output*" p15 [I recall it as "production possibility frontier" from Baumol and Blinder?]

Mankiw N.G., Taylor M.P., Macroeconomics (European Edition), Worth, 2008

"Models have two kinds of variables: endogenous variables and exogenous variables. **Endogenous variables** are those variables a model tries to explain. **Exogenous variables* are those variables that a model takes as given p10"

[Exo variables --> Model --> End variables]

[The intersection of upward-sloping supply curves and downward-sloping demand curvers along the Y-axis of price and the X-axis of quantity is the market equilibrium, which includes the equilibrium price on the Y axis and the equilibrium supply on the X axiz. A rightward shift in demand represents and increase in aggregate demand and a leftward shift in supply represents a reduction in supply (e.g., from increase in component costs)]

"Although market-clearing models assume that all wages and prices are **flexible**, in the real world some wages and prices are **sticky**" p15

"GDP is .. *the total income of everyone in the country* [or] ... *the total expenditure on the economy's output on goods and services*." p22

[It is a circular flow. Households provide labour to firms who provide income in return. Households spend money to firms who provide goods. The income/expenditure, goods/labour values should be the same.]

"*Gross domestic product (GDP) is the market value of all final goods and services produced within an economy in a given period of time* p25

The **GDP deflator**, alspo called the *implicit price deflator for GDP*, is the ratio of nominal GDP to real GDP

GDP Deflator = Nominal GDP / Real GDP

Nominal GPD = Real GDP x GDP Deflator

Real GDP = Nominal GDP / GDP Deflator"

"In 2003, the [UK] ONS ... emphasizes *chained-volume* measures of real GDP. With these new measures , the base year changes continuously over time. In essence, average prices in 2006 and 2007 are used to measure real growth from 2006 to 2007 [etc] .. This new chained-volume meaure of real GDP is better ... because it ensures that the prices used to computer real GDP are never far out of date" p32


"*Gross capital formation* is actually a fancy way of saying total investment..." p32

"**Net exports** are the value of goods and services exported to other countries minues the value of goods and services that foreigners provide us with" p33

"... we can define the macroeconomist's four categories of expenditure as:

* Consumption (C) ..
* Investment (I) ..
* Government Purchases (G) ..
* Net Exports (NX) ..

Y = C + I + G + NX" p34

"To obtain the *gross national product (GNP)* we add receipts of the factor income (wages, rent, interest payments and profit) from the rest of the world and subtract payments of factor income to the rest of the world

GNP = GDP + Factor Payments from Abroad - Factor Payments to Abroad" p40

To obtain *net national product* (NNP), we subtract the depreciation of capital ...

NNP = GNP - Depreciation
" p40

"The first difference is that the GDP deflator measures the prices of all goods and services produced, whereas the CPI measures the prices of goods and services bought by consumers..

The second difference is that the GDP deflator includes only those goods produced domestically. Imported goods are not part of the GDP and do not show up in the GDP deflator...

The third and most subtle difference results from the way the two measure aggregate the many prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights" p44

[Not much variation in practise .. but it is possible!

Fixed-basket CPI has problems with substitute goods, e.g., apple shortage may be substituted with pears, the introduction of new goods, unmeasured changes in quality. CPI typically overstates inflation.]

"There are two basic ways of measuring the unemployment rate in the economy... the *claimant count* method ... a more reliable method, which is now recommended by the International Labour Organisation (ILO)... measures unemployment through the use of questionairre surveys" p39-40

Labour Force = Number of Employed + Number of Unemployed

Unemployment Rate = Number of Unemployed / Labour Force * 100 p80

Blanchard, O., Macroeconomics (Fifth Edition), Pearson International Edition, 2009.

"The unemployment rate in the four largest continental European countries has gone from being much lower than the U.S. unemployment rate to much higher" p33

1. GDP is the value of the final goods and services produced in the economy during a given period
2. GDP is the sum of value added in the economy during a given period
3. GDP is the sum of incomes in the economy during a given period"