Macroeconomic’s midterm

Chapters 2, 3, 4 and 18

CHAPTER 2:

1. Aggregate output = GDP

The measure of aggregate output is called gross domestic product
National income and product accounts were developed at the end of world war ll as
measures of aggregate output.
National income accounts: a measure of the level of aggregate economic activity in a
country
National income & product accounts (NIPA): The system of national income accounts used
in US.

GDP= The market value od all final goods and services produced within the borders of a
country during a particular time period.
GDP= Total production = Total Expenditure = Total Income

2. What isn’t measured by GDP

 Depreciation: GDP omits depreciation of the physical capital stock and resource.
 Non-market transactions:
o GDP excludes home production of cleaning, cooking, and child care done in
the household
o GDP does not capture transactions conducted in the underground economy.
 Externalities: GDP does not count externalities such as pollution, noise, and crime or
positive externalities such as education.
 Leisure
 Quality improvements
 Inequality
 GDG does not include production by U.S. workers and U.S. capital abroad.
3. How can Aggregate output be measured?

3 DIFFERENT WAYS:
 Production approach: Production-based accounting sums up each firm’s value
added, which is the firm’s sales revenue minus the firm’s purchases of intermediate
products from other firms.
 Income approach: income-based accounting sums up payments (or income)
received by labor and the owners of physical or financial capital
 Expenditure approach: expenditure-based accounting sums up the purchases of
goods and services by different groups or categories
There are 5 main categories: C+I+G+X-M

Example 1:

Penville is a small country with one employer, Bic Pen, which produces 10 million pens a year. The
market price of a pen is $2. Penville has 100,000 citizens who are the workers in the factories. Bic
Pen owns the inputs and its own machines so only needs to hire workers. 22 1. Aggregate Output 1.
1. To determine the market value of production, we multiply the quantity of pens produced by the
market price of each pen:

Production = (10 million pens) × ($2.00 / pen) = $20 million

 Macroeconomic’s midterm

2. We add up payments to labor and payments to capital:

Income = $X + ($20 million ‒ $X) = $20 million where X is payments to labor

3. We add up the sales of pens to households, firms, government, and the foreign sector, including
unsold inventories:

Expenditure = (10 million pens) × ($2.00 / pen) = $20 million

EXAMPLE 2:

Consider an economy with two firms, Firm 1 and Firm 2.

Is aggregate output the sum of the values of all goods produced, i.e., $300? Or just the value of cars,
i.e., $200? Steel is an intermediate good, which is a good used in the production of another good

1. GDP is the value of final goods and services produced in the economy during a given period.
◦ We want to count only final goods, not intermediate goods. ◦ If we merge the two firms in
the previous example, the revenues of the new firm equal $200.

2. GDP is the sum of value added in the economy during a given period. ◦ The value added by a
firm is the value of its production minus the value of the intermediate goods used in
production. ◦ In the two-firm example, the value added equals $100 + $100 = $200.
So far, we have looked at GDP from the production side
3. GDP is the sum of incomes in the economy during a given period. Aggregate produc9on and
aggregate income are always equal. From the income side, valued added in the two-firm
example is equal to the sum of labor income ($150) and capital or profit income ($50), i.e.,
$200.

What is included in GDP and what is not?

Only considers final goods and services Intermediate goods are not included in GDP calculations

 For example, if Alcoa sells aluminum to Ford to make a Focus ST.

 The sale of the car is included in GDP, but not the sale of the aluminum

Included:

 Governemtn spending on good/services

 Factory production
 Healthcare expenditures
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 Ingredients and food purchased

 Kids in day care

Not included:

 Government transfer payments

 Environmental conditions
 A measure of nation’s health
 Time spent cooking at home
 Babysitter

Nominal GDP is the sum of the quantities of final goods produced times their current price ( +
quantities of final goods produced * current price). Is also called dollar GDP, or GDP in current
dollars. .

 The production of most goods increases

 The price of most goods increase

Our goal is to measure production and its change over time

Real GDP is the sum of quantities of final goods times constant (not current) prices. Is also called
GDP in terms of goods, GDP in constant dollars, GDP adjusted for inflation, or GDP in chained (2009)
dollars, or GDP in 2009 dollars.

EXAMPLE 3:

Calculate nominal GDP for 2012 and 2013. Calculate real GDP for 2012 and 2013

Nominal GDP for 2012:

$4.00 * 20 + $2.00 * 50 = $80 +$100 = $180

Nominal GDP for 2013:

$5.00 * 30 + $ 2.00 * 100 = $150 +$ 200 =350

Real GDP for 2012:  PRICES REMIAN CONSTANT FROM THE 1ST YEAR

$4.00 * 2’ + 2.00 * 50 = $80 + $100 = 180

Real GDP for 2013:

$4.00 * 30 + $2.00 * 100 = $120 + $200= 320

 Macroeconomic’s midterm

EXAMPLE 4:

Real GDP in 2008 (in 2009 dollars) = 10 cars x $24,000 per car = $240,000.

Real GDP in 2009 (in 2009 dollars) = 12 cars x $24,000 per car = $288,000.

Real GDP in 2010 (in 2009 dollars) = 13 cars x $24,000 per car = $312,000

GDP growth in year t is:

(Yt – Yt-1)/ Yt-1

The unemployment rate:

Employment: is the number of people who have a job

Unemployment: is the number of people who don’t have a job but are looking for one.

The labor force is the sum of employment and unemployment

L=N+U

Labor force = Employment + Unemployment

The unemployment rate is the ratio if the number of people who are unemployed to the number of
people in the labor force.

U
u=
L
The unemployment rate:

Most rich countries rely on large surveys of households to compute the unemployment rate

The U.S. Current Population Survey (CPS) relies on interviews of 60,000 households every month.

A person is unemployed if she does not have a job and has been looking for it in the las 4 weeks.

Those who do not have a job and are not looking for one are counted as not in the labor force.

Discourage workers are those who give up looking for a job and so no longer counted as
unemployed.

The participation rate is the ratio of the labor force to the total population of working age (15-65
years old)

Because of discourage workers, a higher unemployment rate is typically associated with a lower
participation rate.
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Key labor marker variables:

N = working age population (15-65 years)

Q= labor force (employed plus unemployed)

U= Unemployed

U
Unemployed rate =
Q
Q
Participation rate =
N
Q−U
Employment/population ratio =
N

INFLATION RATE:

The percentage change in a price index

Inflation is a sustained rise in the general level of prices – the price level.

The inflation rate is the rate at which the price level increases

Deflation is a sustained decline in the price level (negative inflation rate)

Disinflation is a reduction in the inflation rate

The CPI and GDP deflator moved together most of the time

Exception: in 1979 and 1980, the increase in the CPI was significantly larger than the increase in the
GDP deflator due to the price of imported goods increasing relative to the price od domestically
produced goods.

Most economists believe the “best” rate of inflation to be a low and stable of inflation between 1%
and 4%

The GDP deflator in year t (P 1) is the ratio of nominal GDP to real GDP in year t:

Pt = Nominal GDPt/Real GDPt = $Yt/Yt

It is called an index number (1 I 2009), which has no economic interpretation.

The rate of change has a clear interpretation: the rate of inflation

Π = (P1- Pt-1) / Pt-1

Defining the price level as the GDP deflator implies a simple relation between nominal GDP, real
GDP, and the GDP deflator:

$Yt = PtYt

Nominal GDP is equal to the GDP deflator times real GDP

 Macroeconomic’s midterm

The rate of growth of nominal GDP is equal to the rate of inflation plus the rate of growth of real
GPD.

EXERCISE:

If the price index is 200 in Year 2012 and 210 in Year 2013, the rate of inflation is:

( Price index∈2013 )−( Priceindex∈2012)

Inflation rate in 2013 = x 100
( Price index∈2012)
= (210-200)/200 * 100 = 5%

The set of goods produced in the economy is not the sme as the set of goods purchased by
consumers because:

 Some of the goods in GDP are sold not to consumers but to firms, to the government, or to
foreigners.
 Some of the goods ought by consumers are not produced domestically but are imported
from abroad.

The consumer price index (CPI) is a measure of the cost of living.

The CPI is published monthly by the Bureau of Labor Statistics (BLS), which collects price data for 211
items in 28 cities.

The CPI gives the cost in dollars of a specific list of goods and services over time.

The GDP deflator and the CPI formula look nearly identical

What are the differences?

1. The GDP deflator includes things not purchased by households, like trains, subways, and
submarines
2. The CPI includes imports like Chinese Laptops
3. Housing-related expenditures like shelter and utility bills have a large weight in the CPI.

We can use price index to make meaningful comparisons across time:

 In 1909, the U.S.; president William Howard Taft was paid $75,000
 In 2013, current U.S. President Barack Obama was paid $400,000

We can convert Taft’s salary to 2013 dollars by applying this formula:

Value in 2013 dollars = ( Priceindex ∈2013 ) ¿ ¿

¿¿
233/9 * 75,000 = 1.9 million

Okun´s Law: Output and Unemployment

The line crossed the horizontal axis where output growth is 3% meaning that it takes a growth rate
of 3% to keep unemployment constant.

Phillips Curve: Unemployment and the inflation rate

The short run, the medium run, and the long run.
 Macroeconomic’s midterm

 In the short run, year-to-year movements in output are primarily driven by movements in
demand.
 In the medium run, the economy tends to return to the level of output determined by supply
factors, such as the capital stock, the level of technology, and the size of the labor force.
 In the long run, the economy depends on its ability to innovate and introduce new
technology, and how much people save, the quality of the country’s education system, thq
quality of the government, and so on.

CHAPTER 3:

The goods market:

Facts about the business cycle:

Short-run fluctuations in the growth rate of output and employment are called the business cycle.

1. Economic booms/expansions are periods of expansion of GDP (positive growth), associated

with increasing employment and declining unemployment.
2. Recessions are periods (lasting at least two quarters) in which real GDP falls (negative
growth)

Output gap:

It is an economic measure of the difference between the actual output for an economy and its
potential output.

The goods market:

When economists think about year-to-year movements in economic activity, the focus on the
interactions among production, income, and demand:

 Changes in demand for goods lead to changes in production

 Changes in production lead to changes in income
 Changes in income lead to changes in the demand for the goods.

GDP = Y

Consumption = C

Investment = I

Government spending= G

Exports = X

Imports = IM

DEMAND FOR GOODS:

Z = C + I + G + X – IM  formula for the total demand for goods

In a closed economy: ( X = IM = 0)

Z = C+ I + G
 Macroeconomic’s midterm

Consumption (C) is a function of disposable income ( Y D), which is the income that remains once
consumers have received government transfers and paid their taxes.

C = C(YD)

C(YD) is called the consumption function

This is behavioral equation that captures the behavior of consumers.

Assume that the consumption functions is a linear relation with 2 parameters, c 0 and c1:

C = c0 + c1YD

c1 is the propensity to consume

c0 is what people would consume if theirs disposable income equals o

changes in c0 reflect changes in consumption for a given level of disposable income.

Disposable income is:

YD = Y -T

Where Y is income and T is taxes minus government transfers

Replacing YD in the consumption function gives:

C = c0 + c1 (Y-T)

Endogenous variables : variables depend on other variables in the model.

Exogenous variables: variables not explained within the model but are instead taken as given

A bar on investmen means investmetn is taken as given.

T and G describe fiscal policy- the chioice of taxes and spending by the govrenment.

G and T are assumed exogenous because:

 Governments do not beahve with the same regularity as consumer of firms

 This book will typically treat G an T as variables chosen by the governmetn and will not try to
explain them within the model.
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The determination of quilibrium output:

 Assume X = IM = 0, so
Z =C+I+G
 Replacing C and I from the consumption functions and the exogeous variables.
C = c0 + c1 (Y-T) + I + G
 Equilibrium in the goods markets requires
Y=Z
 This is an equilibrium condition

In equilibrium, production (Y) is equal to demand, which in turn depends on income (Y), which is
itself equal to production.

Macroeconomists always use 3 tools:

1. Algebra to make sure that the logic is correct

2. Graphs to build the tuition
3. Words to explian the results.

Autonomous spending: [ c0 + I + G -c1T]

Autonomous spending is positive because if T = G (balanced budget) and c 1 is between 0 and 1, them
(G-c1T) is positive, and so is aoutonomous spending.

The term 1/(1-c1) is the multiplier, which is larger when c 1 is closer to 1

If c1 equals 0.6, the multiplier equals 1/(1-0.6) = 2.5, meaning that an increase of consumption by 1
billion will increase output by 2.5 * 1 billion = 2.5 billion.

AB : First-round increase in production

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BC : first-round increase in income

CD: second-round increase in demand

DE: second-round increase in production and income

The total increase in production after n+1 rounds:

1 + c1 + c12 + c1n

Which is a geometric series with a limit pf 1/1-c 1

The adjustment of output over time is called the dynamics of adjustment. How long the adjustment
takes depends on how and when firms revise their production schedule.

Investment Equals Saving: An Alternative Way of Thinking about Goods—Market Equilibrium

John Maynar Keynes articulated an alternative model that focuses instead on investment and saving
in the General Theory of Employment, Interes and money in 1936

Private saving (S) is

S = YD – C

S = Y - T- C

By definition, public saving = T – G

Public saving > 0 <-> Budget surplus

Public saving < 0 <-> Budget deficit

In equilibrium:

Y=C+I+G

Subtract T from both sides and move C to the left side:

Y–T–C=I+G–T

The left side of the equation is simply S, so:

S=I+G–T

Or equivalently

I = S + (T – G)

This is the IS relation, which stands for “Investment equals Saving”

Two equivalent ways of stating the condition for equilibrium in the goods market:

Production = Demand

Investment = Saving

Consumption behavior implies that:

 Macroeconomic’s midterm

S=Y–T–C

= Y – T – c0 -c1(Y-T)

(1-c1) is called the propensity to save, which is between 0 and 1.

In equilibrium, I = S, so that equation becomes:

I = c0 + (1- c1) (Y - T)+ (T – G)

Solve for output:

1
Y= [c0 + I + G – c1T]
1−c 1

CHAPTER 4:

CHAPTER 18:

Paid