EBE – YEAR 1 - MACROECONOMICS
CHAPTER 1 – THE SCIENCE OF MACROECONOMICS
- How economists think
o Tools: terminology, data, way of thinking
- Theory as a model building
o Mathematical variables → GDP, inflation, unemployment
▪ Relationship among the variables
o Two kinds of variables
▪ Endogenous
• Those variables that a model explains
• Determined within the model → output
• Example: price of pizza and quantity exchanged → variables
that the model explains
▪ Exogenous
• Those that a model takes as given
• Come from outside the model → input
• Example: aggregate income and price of materials → model
does not explain them – take them as given
o Exogenous variables → model → endogenous variables
- Demand for pizza
o Depends on the price of pizza P and aggregate income Y
o Qd = D(P,Y)
- Supply of pizza
o Depends on the price of pizza P and the price of materials Pm
o QS = S(P,Pm)
- Market is in equilibrium
o QS = Qd
o Holding aggregate income constant
o Supply curve slopes upward (higher price → selling is more profitable)
o Equilibrium price → consumers choose to buy the amount of pizza that
pizzerias choose to produce
o It is simplified – does not consider for example that every pizzeria has a
different location
▪ Is it realistic? → depends on our purpose
o The art of economics → judging and simplifying assumptions
- Using functions to express relationships among variables
o Function = mathematical concept that shows how one variable depends on a
set of other variables
o Qd = D(P,Y)
▪ Qd → quantity of pizza demanded is a function of price of pizza P and
aggregate income Y
▪ D is the function expressing hwo the variables determine the quantity
of pizza demanded
, o Qd = 60 – 10P + 2Y
o D(P,Y) = 60 – 10P + 2Y
▪ For any price of pizza and aggregate income → this function gives the
corresponding quantity of pizza demanded
▪ Example: Y=€10, P=€2 Qd = 60 pies
▪ Example: Y=€10, P=€3 Qd = 50 pies
- Use of multiple models
o Example: to study the impact of minimum wage laws, effect of inflation on
interest rates…
o To explain different phenomena
o Not single one is 100% correct
- PRICES: flexible vs sticky
o Concerning the speed at which wages and prices adjust to changing
conditions
o If they adjust quickly to changing conditions → flexible
▪ Markets are normally in equilibrium
▪ Assumption = market clearing
▪ Prices adjust instantly to changes in supply and demand
o Sometimes does not hold → prices are sticky
▪ Take time to adjust
▪ Wages → sometimes up to three years
▪ Example: magazine subscriptions (3-4 years)
▪ But prices are not stuck forever→ eventually they adjust
- Macroeconomic thinking and macroeconomic models
o Microeconomics → study of how households and firms make decisions
▪ They try to maximize utility
▪ Households decide how much pizza to buy, pizzerias decide how much
pizza to supply
▪ Households make decisions to maximize utility, firms to maximize
profit
o Linked with macroeconomics
o Macroeconomic models do not necessarily focus on the optimizing behaviour
of households and firms
- This book
o Part 1 → Introduction
o Part 2 → Classical theory – Economy in the long run
▪ Classical model, prices are flexible, markets clear
▪ Analysing a time horizon at least several years
o Part 3 → economy in very long run
▪ Build on classical model
▪ Emphasis on growth in capital stock, labour force, technological
knowledge
▪ How the economy evolves over period of decades
o Part 4 → Business cycle – economy in the short run
, ▪ Prices are sticky, non-market-clearing model
▪ Analysing changes from month to month or year to year
o Part 5 → Macroeconomic theory and policy
▪ Models of consumer behaviour
▪ Government policies, debt, financial crisis
CHAPTER 2 – THE DATA OF MACROECONOMICS
- Macroeconomics rely on theory and observation → more systematic observations
judge the theories
- Source of information → data (from surveys)
o To compute statistics that summarize the state of the economy
o GDP → nation´s income and total expenditure on its output of goods and
services
o CPI → measures the level of prices
o Unemployment rate → the fraction of workers that are unemployed
- Measuring the value of economic activity: GROSS DOMESIC PRODUCT
o The best measure of how well the economy is performing
o Measured every three months by the Bureau of Economic Analysis
▪ Sources: administrative data, statistical data
o Purpose: to summarise all these data with a single number representing the
dollar value of economic activity in a given period of time
o GDP
▪ The total income of everyone in the economy
▪ The total expenditure on the economy´s output of goods and services
▪ → gauge of economic performance
o How can GDP measure both income and expenditure on output?
▪ They are really the same → income must equal expenditure
- INCOME, EXPENDITURE AND THE CIRCULAR FLOW
o Example: single good – bread, single input – labour
o Flow of bread and labour
▪ Households sell their labour to the firms
▪ Firms use labour of their workers to produce bread
▪ Firms sell bread to households
▪ Labour flows from households to firms, bread flows from firms to
households
o Flow of dollars
▪ Households buy bread from the firms
▪ Firms use some of the revenue from the sales to pay the workers –
remainder is the profit to the owners
▪ Expenditure on bread flows from households to firms, and income in
the form of wages and profit flows back to households
o GDP measures the flow of dollars in the economy
▪ The sum of wages and profit
▪ Also the total expenditure on purchases of bread
, o To compute GDP we can either look at the flow of dollar from firms to
households or the flow of dollar from households to firms
▪ Must be equal
▪ Very expenditure must affect income and expenditure
- Stocks and flows
o Measure quantity
o Stock → quantity measured at a given point in time
▪ Example:
• The amount of water in the bathtub
• Person´s wealth
• Number of unemployed people
• Amount of capital in economy
• Government debt
o Flow → quantity measured per unit of time
▪ Example:
• The quantity of water coming out of the faucet (quantity
added)
• GDP is a flow variable
• Person´s income
• The number of people losing their jobs
• The amount of investment
• Government budget deficit
o Often connected → the flow of water represents the change in the stock
- RULES FOR COMPUTING GDP
o Gross domestic product is the market value of all final goods and services
produced within an economy in a given period of time
- Example: Apples and Oranges
o 4 apples and 3 oranges → not the same price
o GDP = (price of apples x quantity of apples) + (price of oranges x quantity of
oranges)
- Used goods
o GDP measures only currently produced goods and services
o Used goods are not included in the GDP
- Inventories
o Example: if workers fail to sell additional bread → how this affect GDP?
o If the bread spoils → no effect on GDP
o If the bread is sold → GDP rises
o If sold out of inventory (similar to used goods) → no effect on GDP
o General rule → when a firm increases its inventory of goods, this investment
inventory is counted as expenditure by the firms owners → increase in GDP
▪ A sale out of inventory → no effect on GDP
- Intermediate goods
o Goods produced in stages
CHAPTER 1 – THE SCIENCE OF MACROECONOMICS
- How economists think
o Tools: terminology, data, way of thinking
- Theory as a model building
o Mathematical variables → GDP, inflation, unemployment
▪ Relationship among the variables
o Two kinds of variables
▪ Endogenous
• Those variables that a model explains
• Determined within the model → output
• Example: price of pizza and quantity exchanged → variables
that the model explains
▪ Exogenous
• Those that a model takes as given
• Come from outside the model → input
• Example: aggregate income and price of materials → model
does not explain them – take them as given
o Exogenous variables → model → endogenous variables
- Demand for pizza
o Depends on the price of pizza P and aggregate income Y
o Qd = D(P,Y)
- Supply of pizza
o Depends on the price of pizza P and the price of materials Pm
o QS = S(P,Pm)
- Market is in equilibrium
o QS = Qd
o Holding aggregate income constant
o Supply curve slopes upward (higher price → selling is more profitable)
o Equilibrium price → consumers choose to buy the amount of pizza that
pizzerias choose to produce
o It is simplified – does not consider for example that every pizzeria has a
different location
▪ Is it realistic? → depends on our purpose
o The art of economics → judging and simplifying assumptions
- Using functions to express relationships among variables
o Function = mathematical concept that shows how one variable depends on a
set of other variables
o Qd = D(P,Y)
▪ Qd → quantity of pizza demanded is a function of price of pizza P and
aggregate income Y
▪ D is the function expressing hwo the variables determine the quantity
of pizza demanded
, o Qd = 60 – 10P + 2Y
o D(P,Y) = 60 – 10P + 2Y
▪ For any price of pizza and aggregate income → this function gives the
corresponding quantity of pizza demanded
▪ Example: Y=€10, P=€2 Qd = 60 pies
▪ Example: Y=€10, P=€3 Qd = 50 pies
- Use of multiple models
o Example: to study the impact of minimum wage laws, effect of inflation on
interest rates…
o To explain different phenomena
o Not single one is 100% correct
- PRICES: flexible vs sticky
o Concerning the speed at which wages and prices adjust to changing
conditions
o If they adjust quickly to changing conditions → flexible
▪ Markets are normally in equilibrium
▪ Assumption = market clearing
▪ Prices adjust instantly to changes in supply and demand
o Sometimes does not hold → prices are sticky
▪ Take time to adjust
▪ Wages → sometimes up to three years
▪ Example: magazine subscriptions (3-4 years)
▪ But prices are not stuck forever→ eventually they adjust
- Macroeconomic thinking and macroeconomic models
o Microeconomics → study of how households and firms make decisions
▪ They try to maximize utility
▪ Households decide how much pizza to buy, pizzerias decide how much
pizza to supply
▪ Households make decisions to maximize utility, firms to maximize
profit
o Linked with macroeconomics
o Macroeconomic models do not necessarily focus on the optimizing behaviour
of households and firms
- This book
o Part 1 → Introduction
o Part 2 → Classical theory – Economy in the long run
▪ Classical model, prices are flexible, markets clear
▪ Analysing a time horizon at least several years
o Part 3 → economy in very long run
▪ Build on classical model
▪ Emphasis on growth in capital stock, labour force, technological
knowledge
▪ How the economy evolves over period of decades
o Part 4 → Business cycle – economy in the short run
, ▪ Prices are sticky, non-market-clearing model
▪ Analysing changes from month to month or year to year
o Part 5 → Macroeconomic theory and policy
▪ Models of consumer behaviour
▪ Government policies, debt, financial crisis
CHAPTER 2 – THE DATA OF MACROECONOMICS
- Macroeconomics rely on theory and observation → more systematic observations
judge the theories
- Source of information → data (from surveys)
o To compute statistics that summarize the state of the economy
o GDP → nation´s income and total expenditure on its output of goods and
services
o CPI → measures the level of prices
o Unemployment rate → the fraction of workers that are unemployed
- Measuring the value of economic activity: GROSS DOMESIC PRODUCT
o The best measure of how well the economy is performing
o Measured every three months by the Bureau of Economic Analysis
▪ Sources: administrative data, statistical data
o Purpose: to summarise all these data with a single number representing the
dollar value of economic activity in a given period of time
o GDP
▪ The total income of everyone in the economy
▪ The total expenditure on the economy´s output of goods and services
▪ → gauge of economic performance
o How can GDP measure both income and expenditure on output?
▪ They are really the same → income must equal expenditure
- INCOME, EXPENDITURE AND THE CIRCULAR FLOW
o Example: single good – bread, single input – labour
o Flow of bread and labour
▪ Households sell their labour to the firms
▪ Firms use labour of their workers to produce bread
▪ Firms sell bread to households
▪ Labour flows from households to firms, bread flows from firms to
households
o Flow of dollars
▪ Households buy bread from the firms
▪ Firms use some of the revenue from the sales to pay the workers –
remainder is the profit to the owners
▪ Expenditure on bread flows from households to firms, and income in
the form of wages and profit flows back to households
o GDP measures the flow of dollars in the economy
▪ The sum of wages and profit
▪ Also the total expenditure on purchases of bread
, o To compute GDP we can either look at the flow of dollar from firms to
households or the flow of dollar from households to firms
▪ Must be equal
▪ Very expenditure must affect income and expenditure
- Stocks and flows
o Measure quantity
o Stock → quantity measured at a given point in time
▪ Example:
• The amount of water in the bathtub
• Person´s wealth
• Number of unemployed people
• Amount of capital in economy
• Government debt
o Flow → quantity measured per unit of time
▪ Example:
• The quantity of water coming out of the faucet (quantity
added)
• GDP is a flow variable
• Person´s income
• The number of people losing their jobs
• The amount of investment
• Government budget deficit
o Often connected → the flow of water represents the change in the stock
- RULES FOR COMPUTING GDP
o Gross domestic product is the market value of all final goods and services
produced within an economy in a given period of time
- Example: Apples and Oranges
o 4 apples and 3 oranges → not the same price
o GDP = (price of apples x quantity of apples) + (price of oranges x quantity of
oranges)
- Used goods
o GDP measures only currently produced goods and services
o Used goods are not included in the GDP
- Inventories
o Example: if workers fail to sell additional bread → how this affect GDP?
o If the bread spoils → no effect on GDP
o If the bread is sold → GDP rises
o If sold out of inventory (similar to used goods) → no effect on GDP
o General rule → when a firm increases its inventory of goods, this investment
inventory is counted as expenditure by the firms owners → increase in GDP
▪ A sale out of inventory → no effect on GDP
- Intermediate goods
o Goods produced in stages
