Chapter 1
Macroeconomics about the economy of countries, focusing on:
- Goods & services market
- Loanable funds market
- Money market
- Labor market
European Union an economic zone (= common European market) where
people, goods, and services can move freely – with a common
currency (= euro area)
Chapter 2
State of health of a country’s economy Þ 3 basic variables
1. Output growth
o Rate of change in output
2. Unemployment rate
o The proportion of workers in the economy who are unemployed and looking
for a job
3. Inflation
o Rate at which the average price of goods in the economy is increasing over
time
Classical theory prediction Þ if markets work perfectly, then a drop in demand (for
labor) would lead to a lower quantity demanded
(workers) and a lower equilibrium price (real wage)
- In the short run, prices and wages are often not
flexible
- Demand is driving supply
Lesson: governments and Central Banks (CB) should use fiscal and monetary policy to
reduce unemployment in the short run.
GDP measure of aggregate (=total) output, which we can look at from the
production side (aggregate production), or income side (aggregate
income); aggregate production and aggregate income are always
equal!
↓
§ Production side, GDP equals the value of the final goods and
services produced in the economy, during a given period
§ Production side, GDP is the sum of value added in the
economy during a given period
§ Income side, GDP is the sum of incomes in the economy,
during a given period
1
,Value added the value of its production minus the value of the intermediate
good used in production
Intermediate good good used in the production of another good (final
Nominal GDP the value of all the goods produced in the economy using
current prices
↓
Nominal GDP increases over time for two reasons:
1. The production of most goods increases over time
2. The price of most goods increases over time
Real GDP the value of all the goods produced in the economy using
constant prices
• real GDP is also called GDP in terms of goods, GDP in
constant prices (euros), GDP adjusted for inflation
• In this book, GDP refers to real GDP and 𝑌! denotes real
GDP in year t
Assessing the performance of the economy from year to year, economists focus on the rate
of growth of real GDP (often called GDP growth)
§ Periods of positive GDP growth are called expansions
§ Periods of negative GDP growth are called recessions
GDP growth in year t is constructed as;
𝒀𝒕 − 𝒀𝒕#𝟏
=
𝒀𝒕#𝟏
Þ expressed as a percentage
Employment (N) the number of people who have a job
Unemployment (U) the number of people who do not have a job but are looking
for one
Labor force (L) the sum of employment and unemployment
L (labor force) = N (employment) + U (unemployment)
Discouraged workers when unemployment is high, some of the unemployed give up
looking for a job and are therefore no longer counted as
unemployed (and counted as not in the labor force)
Participation rate the ratio of the labor force to the total population of working
age
2
,Why do economists care about unemployment?
§ Because of its direct effect on the welfare of the unemployed
§ Provides a signal that the economy is not using some of its resources
Inflation sustained rise in the general level of prices
Þ inflation rate is the rate at which the price level
increases
Deflation sustained decline in the price level
Þ corresponds to a negative inflation rate
Increases in nominal GDP can either come from an increase in real GDP of an increase in
prices
§ If nominal GDP increases faster than real GDP, the difference must come from an
increase in prices
↓
Motivates the need for the GDP deflator. The GDP deflator in year t, 𝑃! , is defined as the
ration of nominal GDP to real GDP in year t;
𝒏𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷𝒕 $𝒀𝒕
𝑷𝒕 = =
𝒓𝒆𝒂𝒍 𝑮𝑫𝑷𝒕 𝒀𝒕
The GDP deflator is an index number, hence is chosen arbitrarily and has no economic
interpretation
§ Its rate of change, 𝑷𝒕 − 𝑷𝒕#𝟏 /𝑷𝒕#𝟏 , denoted by 𝜋! , has a clear economic
interpretation; it gives the rate at which the general level of prices increases over
time (= inflation rate)
§ Relation between nominal GDP, real GDP, and GDP deflator; $𝒀𝒕 = 𝑷𝒕 𝒀𝒕
GDP deflator gives the average price of output Þ the final goods produced in the economy.
Not the same as the average price of consumption for two reasons:
1. Some of the goods in the GDP are not sold to consumers but to firms, government or
foreigners
2. Some of the goods bought by consumers are not produced domestically but are
imported
To measure the average price of consumption (equivalently the cost of living), economists
look at CPI (= consumer price index). Þ Attempts to represent the consumption basket of a
typical urban consumer
Why do economists care about inflation?
§ During periods of inflation, not all prices and wages rise proportionally. Thus,
inflation affects income distribution.
§ Also leads to other distortions. Variations in relative prices also lead to more
uncertainty, making it harder for firms to make decisions about the future, e.g.
investment decisions.
3
, Three main dimensions of aggregate economic activity:
1. Output growth (GDP)
2. Unemployment rate
3. Inflation rate
Okun’s law if output growth is high, unemployment will decrease
↓
Important implication: the key to decreasing unemployment is a high
enough rate of growth
↓
It takes an annual growth rate of about 2% to keep unemployment
constant, for two reasons:
1. Population (labor force) increases over time, thus employment
must grow to keep the unemployment rate constant
2. Output per worker also increases, implying that output growth is
higher than employment growth
Phillips curve when unemployment becomes very low, the economy is likely to
overheat, leading to upward pressure on inflation
Core inflation rate inflation rate constructed by leaving out volatile prices, such as food
and energy
Fundamental determinants of a country’s level of output:
§ How advanced its technology is
§ How much capital it is using
§ The size and the skills of its labor force
Implying factors such as education system, savings rate, and the quality of its government
What determines the level of output in an economy?
§ In the short run (few years), year-to-year movements in output are primarily driven
by movements in demand. Changes in demand can lead to a decrease in output
(=recession) or an increase in output (=expansion)
§ In the medium run (decade), the economy tends to return to the level of output
determined by supply factors: capital stock, level of technology, size of labor force.
Over a decade, these factors move sufficiently slowly that we can take them as
given.
§ In the long run (a few decades, or more), we must look at factors like the education
system, the saving rate, and the role of the government.
4
Macroeconomics about the economy of countries, focusing on:
- Goods & services market
- Loanable funds market
- Money market
- Labor market
European Union an economic zone (= common European market) where
people, goods, and services can move freely – with a common
currency (= euro area)
Chapter 2
State of health of a country’s economy Þ 3 basic variables
1. Output growth
o Rate of change in output
2. Unemployment rate
o The proportion of workers in the economy who are unemployed and looking
for a job
3. Inflation
o Rate at which the average price of goods in the economy is increasing over
time
Classical theory prediction Þ if markets work perfectly, then a drop in demand (for
labor) would lead to a lower quantity demanded
(workers) and a lower equilibrium price (real wage)
- In the short run, prices and wages are often not
flexible
- Demand is driving supply
Lesson: governments and Central Banks (CB) should use fiscal and monetary policy to
reduce unemployment in the short run.
GDP measure of aggregate (=total) output, which we can look at from the
production side (aggregate production), or income side (aggregate
income); aggregate production and aggregate income are always
equal!
↓
§ Production side, GDP equals the value of the final goods and
services produced in the economy, during a given period
§ Production side, GDP is the sum of value added in the
economy during a given period
§ Income side, GDP is the sum of incomes in the economy,
during a given period
1
,Value added the value of its production minus the value of the intermediate
good used in production
Intermediate good good used in the production of another good (final
Nominal GDP the value of all the goods produced in the economy using
current prices
↓
Nominal GDP increases over time for two reasons:
1. The production of most goods increases over time
2. The price of most goods increases over time
Real GDP the value of all the goods produced in the economy using
constant prices
• real GDP is also called GDP in terms of goods, GDP in
constant prices (euros), GDP adjusted for inflation
• In this book, GDP refers to real GDP and 𝑌! denotes real
GDP in year t
Assessing the performance of the economy from year to year, economists focus on the rate
of growth of real GDP (often called GDP growth)
§ Periods of positive GDP growth are called expansions
§ Periods of negative GDP growth are called recessions
GDP growth in year t is constructed as;
𝒀𝒕 − 𝒀𝒕#𝟏
=
𝒀𝒕#𝟏
Þ expressed as a percentage
Employment (N) the number of people who have a job
Unemployment (U) the number of people who do not have a job but are looking
for one
Labor force (L) the sum of employment and unemployment
L (labor force) = N (employment) + U (unemployment)
Discouraged workers when unemployment is high, some of the unemployed give up
looking for a job and are therefore no longer counted as
unemployed (and counted as not in the labor force)
Participation rate the ratio of the labor force to the total population of working
age
2
,Why do economists care about unemployment?
§ Because of its direct effect on the welfare of the unemployed
§ Provides a signal that the economy is not using some of its resources
Inflation sustained rise in the general level of prices
Þ inflation rate is the rate at which the price level
increases
Deflation sustained decline in the price level
Þ corresponds to a negative inflation rate
Increases in nominal GDP can either come from an increase in real GDP of an increase in
prices
§ If nominal GDP increases faster than real GDP, the difference must come from an
increase in prices
↓
Motivates the need for the GDP deflator. The GDP deflator in year t, 𝑃! , is defined as the
ration of nominal GDP to real GDP in year t;
𝒏𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷𝒕 $𝒀𝒕
𝑷𝒕 = =
𝒓𝒆𝒂𝒍 𝑮𝑫𝑷𝒕 𝒀𝒕
The GDP deflator is an index number, hence is chosen arbitrarily and has no economic
interpretation
§ Its rate of change, 𝑷𝒕 − 𝑷𝒕#𝟏 /𝑷𝒕#𝟏 , denoted by 𝜋! , has a clear economic
interpretation; it gives the rate at which the general level of prices increases over
time (= inflation rate)
§ Relation between nominal GDP, real GDP, and GDP deflator; $𝒀𝒕 = 𝑷𝒕 𝒀𝒕
GDP deflator gives the average price of output Þ the final goods produced in the economy.
Not the same as the average price of consumption for two reasons:
1. Some of the goods in the GDP are not sold to consumers but to firms, government or
foreigners
2. Some of the goods bought by consumers are not produced domestically but are
imported
To measure the average price of consumption (equivalently the cost of living), economists
look at CPI (= consumer price index). Þ Attempts to represent the consumption basket of a
typical urban consumer
Why do economists care about inflation?
§ During periods of inflation, not all prices and wages rise proportionally. Thus,
inflation affects income distribution.
§ Also leads to other distortions. Variations in relative prices also lead to more
uncertainty, making it harder for firms to make decisions about the future, e.g.
investment decisions.
3
, Three main dimensions of aggregate economic activity:
1. Output growth (GDP)
2. Unemployment rate
3. Inflation rate
Okun’s law if output growth is high, unemployment will decrease
↓
Important implication: the key to decreasing unemployment is a high
enough rate of growth
↓
It takes an annual growth rate of about 2% to keep unemployment
constant, for two reasons:
1. Population (labor force) increases over time, thus employment
must grow to keep the unemployment rate constant
2. Output per worker also increases, implying that output growth is
higher than employment growth
Phillips curve when unemployment becomes very low, the economy is likely to
overheat, leading to upward pressure on inflation
Core inflation rate inflation rate constructed by leaving out volatile prices, such as food
and energy
Fundamental determinants of a country’s level of output:
§ How advanced its technology is
§ How much capital it is using
§ The size and the skills of its labor force
Implying factors such as education system, savings rate, and the quality of its government
What determines the level of output in an economy?
§ In the short run (few years), year-to-year movements in output are primarily driven
by movements in demand. Changes in demand can lead to a decrease in output
(=recession) or an increase in output (=expansion)
§ In the medium run (decade), the economy tends to return to the level of output
determined by supply factors: capital stock, level of technology, size of labor force.
Over a decade, these factors move sufficiently slowly that we can take them as
given.
§ In the long run (a few decades, or more), we must look at factors like the education
system, the saving rate, and the role of the government.
4
