The Macroeconomic Perspective

Macroeconomics focuses on the economy as a whole (or on whole economies as they interact)
Macroeconomic externality - occurs when what happens at the macro level is different from and
inferior to what happens at the micro level. The economy as a whole is massive.
Economic indicators - statistics that measure one or more aspects of the macro economic
◦ Measures of aggregate production, like GDP
◦ Measures of employment and unemployment, and measures of inflation, like the percent change in the
Consumer Price Index

Misery Index - the sum of the inflation and unemployment rates as a measure of how bad (i.e.,
miserable) the economy is.

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Macroeconomic Goals, Framework, and Policies

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Goals
In thinking about the overall health of the macroeconomy, it is useful to consider three primary
goals: economic growth, full employment (or low unemployment), and stable prices (or low
inflation):
Economic growth ultimately determines the prevailing standard of living in a country.
Unemployment, as measured by the unemployment rate, is the percentage of people in the
labor force who do not have a job.
Inflation is a sustained increase in the overall level of prices.

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 Frameworks
Economists use theories and models to explain and understand economic principles.
In microeconomics, we used the theories of supply and demand; in macroeconomics, we use
the theories of aggregate demand (AD) and aggregate supply (AS).
This book presents two perspectives on macroeconomics: the Neoclassical perspective and the
Keynesian perspective, each of which has its own version of AD and AS. Between the two
perspectives, you will obtain a good understanding of what drives the macroeconomy

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 Policy Tools
National governments have two sets of tools for influencing the macroeconomy:
◦ Monetary policy, which involves managing the interest rates and the availability of credit.
◦ Fiscal policy, which involves changes in government spending/purchases and taxes.

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 What is Gross Domestic Product?
Gross Domestic Product (GDP): the value of the output of all
goods and services produced within a country in a year
The measurement of GDP involves counting up the production of
millions of different goods and services—smart phones, cars,
music downloads, computers, steel, bananas, college educations,
and all other new goods and services produced in the current
year—and summing them into a total dollar value.
Take the quantity of everything produced, multiply it by the price
at which each product sold, and add up the total. In 2016, the U.S.
GDP totaled $18.6 trillion, the largest GDP in the world

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 Gross Domestic Product (GDP) cont.
Final goods and services: goods or services at the furthest stage of their production at the end end of
a year; that is, they have either been sold to consumers, or they are intermediate goods or raw
materials that have not yet been used to produce final goods
What is counted in GDP?
◦ Final goods and services
◦ Intermediate goods that have not yet been used in final goods and services
◦ Raw materials that have been produced, but not yet used in the production of intermediate or final goods

What is not included in GDP?

◦ Intermediate goods that have been turned into final goods and services
◦ Used goods
◦ Transfer payments
◦ Non-market activities
◦ Illegal goods

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Calculating GDP
If we know that GDP is the measurement of everything that is produced, we should also ask the
question, who buys all of this production? This demand can be divided into four main parts:
1. Consumer expenditure (consumption)
2. Investment expenditure
3. Government expenditure on goods and services
4. Net export expenditure

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 Components of U.S. GDP
Table 1. Components of U.S. GDP in 2016: From
the Expenditure Side

Components
of GDP (in Percentage of
Category
trillions of Total
dollars)

Consumption $12.8 68.7%

Investment $3.0 16.3%

Government $3.3 17.6%

Net Exports -$.50 -2.7

Exports $2.2 12.0%

Imports –$2.7 –14.7%

Total GDP $18.6 100%

Source: http://bea.gov/ Table 1.1.5 Gross

Domestic Product
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Calculating GDP Vocabulary
Durable Good: a good that last three years or more, such as a car or refrigerator
Inventory: good that has been produced, but not yet been sold
National Income: includes all income earned: wages, profits, rent, and profit income
Nondurable Good: a good that lasts less than three years, such as food and clothing
Service: product which is intangible (in contrast to goods) such as entertainment, healthcare, or
education
Structure: building used as residence, factory, office building, retail store, or for other purposes

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Calculating GDP Vocabulary (cont.)
Trade Balance: gap between exports and imports
Trade Deficit: exists when a nation’s imports exceed its exports and is calculated as imports –
exports
Trade Surplus: exists when a nation’s exports exceed its imports and is calculated as exports –
imports

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Gross National Product
Gross National Product (GNP): includes what is produced domestically and what is produced by
domestic labor and business abroad in a year
◦ Includes only what is produced within a country’s borders
◦ Adds what is produced by domestic business and labor abroad
◦ Subtracts out any payments sent home to other countries by foreign labor and businesses located in the
U.S.

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Net National Product
Net National Product (NNP): GDP minus depreciation
Depreciation: the process by which capital ages and loses value
National Income: all income to businesses and individuals
Personal Income: income made by individuals

Net national product (NNP) is calculated by taking GNP and then subtracting the value of how
much physical capital is worn out, or reduced in value because of aging, over the course of a year.
The process by which capital ages and loses value is called depreciation. The NNP can be further
subdivided into national income, which includes all income to businesses and individuals,
and personal income, which includes only income to people

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 Nominal and Real Value
Nominal Value: an economic statistic measured
using actual market prices; i.e. nominal values are
not adjusted for inflation; contrast with real value
Real Value: an economic statistic measured after it
has been adjusted for inflation; contrast with
nominal value

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 Comparing Nominal and Real GDP
If an unwary analyst compared nominal GDP in 1960 to
nominal GDP in 2010, it might appear that national output
had risen by a factor of nearly twenty-seven over this
time. This conclusion comes from the simple growth rate
formula (or percentage change formula):
𝐹𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐺𝐷𝑃
= 𝐺𝑟𝑜𝑤𝑡ℎ 𝑜𝑓 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐺𝐷𝑃
This conclusion, though, would be highly misleading.
Recall that nominal GDP is defined as the quantity of
every final good or service produced multiplied by the
price at which it was sold, summed up for all goods and
services. In other words, nominal GDP is the value of
output produced:
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑂𝑢𝑡𝑝𝑢𝑡 =
𝑃𝑟𝑖𝑐𝑒 x 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓𝑂𝑢𝑡𝑝𝑢𝑡𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑂𝑢𝑡𝑝𝑢𝑡 =
𝑃𝑟𝑖𝑐𝑒 x 𝑜𝑓 𝑂𝑢𝑡𝑝𝑢𝑡
We’ll call this the Real-to-Nominal formula.
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Comparing Nominal and Real GDP Vocab
Simple Growth Rate Formula: the growth rate (or percentage change) of any variable X over
time is (the value of X in the final period – the value of X in the initial period)/(the value of X in
the initial period)
Real-To-Nominal Formula: the nominal value of some economic variable (e.g. GDP) is the price
level times the real value of that economic variable

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Comparing Nominal and Real GDP
Price of Quantity of Value of Price of Quantity of Value of
Year
Apples Apples Apples Xylophones Xylophones Xylophones

Year
$0.50 2000 lbs $1,000 $10 100 $1,000
One

Year
$0.55 2182 lbs $1,200 $12 150 $1,800
Two

• Nominal output is the value of what’s produced, while real output

is the quantity of what’s produced (in the previous case, pounds
of apples). If we produce more apples we can say our real output
has increased.
• Now suppose our apply economy from above now produces two
goods: apples and xylophones.
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 Comparing Nominal and Real GDP 2
Price of Quantity of Value of Price of Quantity of Value of
Year
Apples Apples Apples Xylophones Xylophones Xylophones

Year
$0.50 2000 lbs $1,000 $10 100 $1,000
One

Year
$0.55 2182 lbs $1,200 $12 150 $1,800
Two

Year 1: the value of apples produced was $1000, and the value of xylophones produced was $1000, so
nominal GDP was $2000.
Year 2: the value of apples produced was $1200, and the value of xylophones produced was $1800, so
nominal GDP was $3000. Thus, nominal GDP increased by $1000 (the increase)/$2000 (the nominal GDP in
year one)= 50%.
But what has happened to real GDP?
Real output of apples has increased from 2000 lbs to 2182 lbs. Real output of xylophones has increased
from 100 to 150. How much has real output increased?
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 Comparing Nominal and Real 3
Quantity of Value of Price of Quantity of Value of
Year Price of Apples
Apples Apples Xylophones Xylophones Xylophones

Year
$0.50 2000 lbs $1,000 $10 100 $1,000
One

Year
$0.55 2182 lbs $1,200 $12 150 $1,800
Two
We use price as a common denominator to “add” quantities of apples and xylophones together. We
can choose the prices from any year as long as we use them with each year’s quantities.
Year 1 REAL GDP: Price of apples year 1×Quantity of apples year 1+Price of xylophones year
1×Quantity of xylophones year 1
Year 2 REAL GDP: Price of apples year 1×Quantity of apples year 2+Price of xylophones year
1×Quantity of xylophones year 2

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 Comparing Nominal and Real GDP 4
Quantity of Value of Price of Quantity of Value of
Year Price of Apples
Apples Apples Xylophones Xylophones Xylophones

Year
$0.50 2000 lbs $1,000 $10 100 $1,000
One

Year
$0.55 2182 lbs $1,200 $12 150 $1,800
Two

In other words, we compute real GDP in every year using the prices that existed in a single year, in
this case year 1. That’s why real GDP is often described as being based on “constant dollars” or “year
one dollars”.
Plugging in the values from the table above, yields:
Real GDP year 1=($0.50×2000)+($10×100)=$2000real GDP year 1=($0.50×2000)+($10×100)=$2000

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 Comparing Nominal and Real GDP 5
Quantity of Value of Price of Quantity of Value of
Year Price of Apples
Apples Apples Xylophones Xylophones Xylophones

Year
$0.50 2000 lbs $1,000 $10 100 $1,000
One

Year
$0.55 2182 lbs $1,200 $12 150 $1,800
Two

Real GDP year 2=($0.50×2182)+($10×150)=$2591real GDP year 2=($0.50×2182)+($10×150)=$2591

In other words real GDP increased by $591/$2000 = 29.6%, which is significantly less than the
increase in nominal GDP of 50%.

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 Converting Nominal to Real GDP
In order to see how much production has actually
increased, we need to extract the effects of higher
prices on nominal GDP, so that what we’re left with is
real GDP, the increase in the quantity of goods and
services produced.
This can be easily done using a concept known as the
GDP deflator.
The GDP deflator is a price index measuring the
average price of all goods and services included in the
economy.

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 Converting Nominal to Real GDP (cont.)
The price level in 2010 was almost six times higher than in 1960 (the deflator for 2010 was 110
versus a level of 19 in 1960).
Clearly, much of the apparent growth in nominal GDP was due to inflation, not an actual change in
the quantity of goods and services produced, in other words, not in real GDP.
Recall that nominal GDP can rise for two reasons: an increase in output, and/or an increase in prices.
What is needed is to extract the increase in prices from nominal GDP so as to measure only changes
in output.

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Converting Nominal to Real GDP (cont. II)
Nominal Value of Output = Price × Quantity of Output

Taking the GDP form of this equation:

Nominal GDP= GDP Deflator × Real GDP

Divide both sides by the GDP Deflator:

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 =
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟

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Converting Nominal to Real GDP (cont.
III)
A price index (like the GDP Deflator) is a two-digit decimal number like 1.00 or 0.85 or 1.25.
Because some people have trouble working with decimals, when the price index is published, it
has traditionally been multiplied by 100 to get integer numbers like 100, 85, or 125.
When we “deflate” nominal figures to get real figures (by dividing the nominal by the price
index), we also need to remember to divide the published price index by 100 to make the math
work. So the formula becomes:

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 Business Cycles
Business Cycle: the relatively short-term movement of the economy from recession to expansion
Depression: an especially lengthy and deep decline in output
Peak: during the business cycle, the highest point of output before a recession begins
Recession: a significant decline in national output typically a minimum of six months
Trough: during the business cycle, the lowest point of output in a recession, before a recovery begins

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Phases of the Business Cycle

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 Tracking Real GDP Over Time
Figure 1 shows the pattern of U.S. real GDP
since 1900. The generally upward long-
term path of GDP has been regularly
interrupted by short-term declines. A
significant decline in real GDP is called
a recession. Recessions typically last at
least six months (or two quarters). An
especially lengthy and deep recession is
called a depression. The severe drop in
GDP that occurred during the Great
Depression of the 1930s is clearly visible in
the figure, as is the Great Recession of
2008–2009.
Real GDP is important because it is highly correlated with other measures of
economic activity, like employment and unemployment. When real GDP rises, so
does employment.

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