Chapter 1 – The science of Macroeconomics
1-2: How economists think
Macroeconomics is the study of the economy as a whole, including growth in incomes, changes in
prices and the rate of unemployment. Macroeconomists attempt both to explain economic events
and to devise policies to improve economic performance.
Economists use models to understand the world; made of symbols and equations
Endogenous variables = ‘the variables a model tries to explain’
Exogenous variables = ‘the variables the model takes as given’
Simplification is necessary within model building and it depends on the question you want to answer
how much (and what variables) you can simplify
Assumptions economists make:
1. Market clearing; markets are usually in equilibrium (not realistic, prices don’t update instantly)
2. Wages and prices are flexible. Reality: wages and prices are sticky
,Chapter 2 – The data of macroeconomics
2-1: Measuring the value of economic activity: Gross Domestic Product
GDP is often considered the best measure of how well the economy is performing
Two ways to view GDP:
1. The total income of everyone in the economy
2. The total expenditure on the economy’s output of goods and services
-> lead to the same values
GDP = ‘the market value of all final goods and services produced within an economy in a given period
of time’
-> Sale of used good is not included within GDP. It is the transfer of an asset not a new addition to
the economy
How to handle inventories:
1. Product in inventory goes to waste; GDP does not change. Company pays more in wages/materials
but that gets deducted from their profit
2. Product in inventory will get sold later. GDP will go up. Company ‘buys’ the product until it can sell
the product. So expenditure rises.
-> When the product is sold later GDP will not go up. (Consumer expenditure rises and company has
inventory disinvestment)
GDP = ‘total value of final goods and services produced’
-> value of intermediate goods is already included in the final price
Value added (of a firm) = value of the firm’s output – value of the intermediate goods the firm
purchases
GDP = ‘total value added of all firms in the economy’
Imputed value = ‘estimated value of a product not sold in a usual marketplace’
-> F.E. housing: renters pay rent, which raises GDP. Homeowners do not pay rent so it does not raise
GDP. To solve this, homeowners pay a fictional rent to themselves to include within GDP
-> Also included is public services
No imputations made for:
- goods produced/consumed within one home
- imputed ‘rent’ on other durables beside housing
- the black/underground/shadow economy = ‘part of the economy that people hide from the
government because they don’t want to pay taxes or because it is illegal’
Because of all the things missing from the GDP, it is an imperfect measure of economic activity. If the
imperfections remain fairly constant across countries however, it can still be an useful tool
Nominal GDP = ‘value of goods and services measured at current prices’
Real GDP = ‘value of goods and services measured using a constant set of prices’
GDP deflator = Nominal GDP / Real GDP
If you use same set of base prices to compute real GDP, it would become very outdated. To solve
, this:
1. They selected a new set of base prices every couple of years.
OR
2. They emphasized chained-volume measures: base year changes continuously. Average prices in
2012 and 2013 are used to measure real growth from 2012 to 2013 and so on.
Dividing GDP using standard national accounts categories:
1. Final consumption expenditure = spending on goods and services purely for their own sake
Further broken down into:
1.1: Households (which also has 4 categories)
- Non-durable goods (food and beverages)
- Durable goods (can be used repeatedly over a period considerably longer than 1 year) (cars and tvs)
- Semi-durable goods (have a slightly lower lifetime than durable and lower cost) (clothing and shoes)
- Services
1.2: Non-profit institutions
1.3: General government consumption
-> Also includes net tourism consumption:
Net tourism consumption = consumption domestic economy by foreign tourists – consumption
domestic residents in foreign countries
2. Gross capital formation = total investments
Broken down into:
2.1: Gross fixed capital formation:
- Business fixed investment: purchasing of new factories/equipment
- General government fixed investment: purchasing of schools/motorways
- Residential fixed investment: purchasing of new housing
2.2 Inventory investment: increase in firm’s inventories of goods
3. Net exports = value of goods and services exported to other countries minus the value of goods
and services that foreigners provide us with
Macroeconomists usually adjust these 3 standards of measures slightly:
- New category for government spending. So it is removed from Gross Capital Formation and Final
Consumption Expenditure
- Lumping together the households and non-profit institutions in the Final Consumption Expenditure
- Moving net tourism from Final Consumption Expenditure to Net Export
What we are left with:
1. Investment (I) (by firms and households)
2. Consumption (C) (households + non-profit institutions)
3. Net exports (NX) (includes net tourism)
4. Government purchases (G) (consumption and investment expenditures)
Total GDP (Y) = C + I + G + NX
-> also called: national income accounts identity
Factor payments = income from factors of production: wages, rent, interest payments and profit
1-2: How economists think
Macroeconomics is the study of the economy as a whole, including growth in incomes, changes in
prices and the rate of unemployment. Macroeconomists attempt both to explain economic events
and to devise policies to improve economic performance.
Economists use models to understand the world; made of symbols and equations
Endogenous variables = ‘the variables a model tries to explain’
Exogenous variables = ‘the variables the model takes as given’
Simplification is necessary within model building and it depends on the question you want to answer
how much (and what variables) you can simplify
Assumptions economists make:
1. Market clearing; markets are usually in equilibrium (not realistic, prices don’t update instantly)
2. Wages and prices are flexible. Reality: wages and prices are sticky
,Chapter 2 – The data of macroeconomics
2-1: Measuring the value of economic activity: Gross Domestic Product
GDP is often considered the best measure of how well the economy is performing
Two ways to view GDP:
1. The total income of everyone in the economy
2. The total expenditure on the economy’s output of goods and services
-> lead to the same values
GDP = ‘the market value of all final goods and services produced within an economy in a given period
of time’
-> Sale of used good is not included within GDP. It is the transfer of an asset not a new addition to
the economy
How to handle inventories:
1. Product in inventory goes to waste; GDP does not change. Company pays more in wages/materials
but that gets deducted from their profit
2. Product in inventory will get sold later. GDP will go up. Company ‘buys’ the product until it can sell
the product. So expenditure rises.
-> When the product is sold later GDP will not go up. (Consumer expenditure rises and company has
inventory disinvestment)
GDP = ‘total value of final goods and services produced’
-> value of intermediate goods is already included in the final price
Value added (of a firm) = value of the firm’s output – value of the intermediate goods the firm
purchases
GDP = ‘total value added of all firms in the economy’
Imputed value = ‘estimated value of a product not sold in a usual marketplace’
-> F.E. housing: renters pay rent, which raises GDP. Homeowners do not pay rent so it does not raise
GDP. To solve this, homeowners pay a fictional rent to themselves to include within GDP
-> Also included is public services
No imputations made for:
- goods produced/consumed within one home
- imputed ‘rent’ on other durables beside housing
- the black/underground/shadow economy = ‘part of the economy that people hide from the
government because they don’t want to pay taxes or because it is illegal’
Because of all the things missing from the GDP, it is an imperfect measure of economic activity. If the
imperfections remain fairly constant across countries however, it can still be an useful tool
Nominal GDP = ‘value of goods and services measured at current prices’
Real GDP = ‘value of goods and services measured using a constant set of prices’
GDP deflator = Nominal GDP / Real GDP
If you use same set of base prices to compute real GDP, it would become very outdated. To solve
, this:
1. They selected a new set of base prices every couple of years.
OR
2. They emphasized chained-volume measures: base year changes continuously. Average prices in
2012 and 2013 are used to measure real growth from 2012 to 2013 and so on.
Dividing GDP using standard national accounts categories:
1. Final consumption expenditure = spending on goods and services purely for their own sake
Further broken down into:
1.1: Households (which also has 4 categories)
- Non-durable goods (food and beverages)
- Durable goods (can be used repeatedly over a period considerably longer than 1 year) (cars and tvs)
- Semi-durable goods (have a slightly lower lifetime than durable and lower cost) (clothing and shoes)
- Services
1.2: Non-profit institutions
1.3: General government consumption
-> Also includes net tourism consumption:
Net tourism consumption = consumption domestic economy by foreign tourists – consumption
domestic residents in foreign countries
2. Gross capital formation = total investments
Broken down into:
2.1: Gross fixed capital formation:
- Business fixed investment: purchasing of new factories/equipment
- General government fixed investment: purchasing of schools/motorways
- Residential fixed investment: purchasing of new housing
2.2 Inventory investment: increase in firm’s inventories of goods
3. Net exports = value of goods and services exported to other countries minus the value of goods
and services that foreigners provide us with
Macroeconomists usually adjust these 3 standards of measures slightly:
- New category for government spending. So it is removed from Gross Capital Formation and Final
Consumption Expenditure
- Lumping together the households and non-profit institutions in the Final Consumption Expenditure
- Moving net tourism from Final Consumption Expenditure to Net Export
What we are left with:
1. Investment (I) (by firms and households)
2. Consumption (C) (households + non-profit institutions)
3. Net exports (NX) (includes net tourism)
4. Government purchases (G) (consumption and investment expenditures)
Total GDP (Y) = C + I + G + NX
-> also called: national income accounts identity
Factor payments = income from factors of production: wages, rent, interest payments and profit
