Lectures 1-2: Macroeconomics: Preliminaries

Gayane Barseghyan

American University of Armenia

January, 2020

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

Lecture 1 Outline

Data of Macroeconomics (Mankiw)

Price Indices: Laspeyres index and Paasche index

Unemployment Rate, Labor Force Participation

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Scope of Macroeconomics

Macroeconomics wants to explain the evolution of the main

economic aggregates over time.
We are interested in why total production (real GDP) grows over
time on average and why it shows sizeable fluctuations around its
long-run growth trend.
In contrast to microeconomics, where the object of interest is a
single firm or household, in macroeconomics we study the whole
economy.
Our reasoning, however, will be based on the insights that
microeconomic theory provides.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

To measure the value of economic activity different statistics are

computed.
The GDP (Gross domestic product) is one of the important
measures.
There are two ways to view this statistic:
GDP is the total income of everyone in the economy
GDP is the total expenditure on the economy’s output of goods
and services.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Definition: Gross domestic product (GDP) is the market value of all

final goods and services produced within an economy in a given period
of time.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Definition: Gross domestic product (GDP) is the market value of all

final goods and services produced within an economy in a given period
of time.

GDP can be determined in three ways,

Production approach: summing up the value added of all
industries in the economy.
Income approach: summing up primary incomes distributed by
resident producer units.
Expenditure approach: summing up the total spending on goods
and services by different sectors of the economy.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

The GDP includes also the imputed values for goods and services that
are not sold in the market place, for instance
housing services enjoyed by homeowners (imputed rent)
government services such as police
The GDP does not include
the imputed values of home production (e.g., cooking, cleaning)
the imputed rents from durable goods (e.g., cars, jewelry)
the imputed value of the output in underground economy.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics
Income approach:
GNP = GDP + Factor Payments from Abroad - Factor Payments
to Abroad.
NNP = GNP - Depreciation.
National Income = NNP - Statistical Discrepancy (because
different data sources may not be completely consistent).
National Income = Compensation of employees + Proprietors’
income + Rental income + Corporate profits + Net interest +
Indirect business taxes
Personal Income = National Income - Indirect Business Taxes -
Corporate Profits - Social Insurance Contributions - Net Interest
+ Dividends + Government Transfers to Individuals + Personal
Interest Income.
Disposable Personal Income = Personal Income - Personal Tax
and Nontax Payments.
Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries
The Data of Macroeconomics

Expenditure approach: umming up the total spending on goods and

services by different sectors of the economy.

Y = C + I + G + (X − M)

where
Y = Nominal GDP
C= Consumption
I = Gross Investment
G= Government Purchases
X= Exports
M= Imports
NX= X-M

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics
Consumption consists of the goods and services bought by
households. It is divided into three subcategories: nondurable
goods (goods that last only a short time (e.g., food, clothing)),
durable goods (goods that last a long time (e.g., car, TV)), and
services (e.g., doctor visits).
Investment consists of goods bought for future use. Investment
is also divided into three subcategories: business fixed
investment (spending on plant and equipment that firms will
use to produce other goods and services), residential fixed
investment (spending on new housing by consumers and
landlords), and inventory investment (the change in firms
inventories of goods). It creates new capital, it has nothing to
do with the reallocation of assets amongst individuals.
Government purchases are the goods and services bought by
federal, state, and local governments. It does not include the
transfer payments to individuals (e.g., the social security).
Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries
The Data of Macroeconomics

The Laspeyres index is computed as:

Pn
(pi,t qi,0 )
PL,t|t−1 = n i=1
P
i=1 (pi,t−1 qi,0 )

The Paasche index is computed as:

Pn
(pi,t qi,t )
PP,t|t−1 = Pn i=1
i=1 (pi,t−1 qi,t )

The Laspeyres index tends to overstate inflation (in a cost of

living framework), while the Paasche index tends to understate it,
because the indices do not account for the fact that consumers
typically react to price changes by changing the quantities that
they buy. For example, if prices go up for good c then, ceteris
paribus, quantities of that good should go down.

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Why does the CPI overstate Inflation?

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Why does the CPI overstate Inflation?

The reasons are (that CPI is not able to capture):

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Why does the CPI overstate Inflation?

The reasons are (that CPI is not able to capture):
substitution bias

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Why does the CPI overstate Inflation?

The reasons are (that CPI is not able to capture):
substitution bias
introduction of new goods

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Why does the CPI overstate Inflation?

The reasons are (that CPI is not able to capture):
substitution bias
introduction of new goods
change in quality

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

A nice property of Laspeyres index:

Pn Pn Pn
i=1 (pi,t qi,0 ) i=1 (pi,t−1 qi,0 ) (pi,1 qi,0 )
PL,t|0 = n
P × n
P × ... × Pni=1 =
(p q
i=1 i,t−1 i,0 ) (p
i=1 i,t−2 i,0q ) i=1 i,0 qi,0 )
(p
Pn
(pi,t qi,0 )
= Pni=1
i=1 (pi,0 qi,0 )

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

A nice property of Laspeyres index:

Pn Pn Pn
i=1 (pi,t qi,0 ) i=1 (pi,t−1 qi,0 ) (pi,1 qi,0 )
PL,t|0 = n
P × n
P × ... × Pni=1 =
(p q
i=1 i,t−1 i,0 ) (p
i=1 i,t−2 i,0q ) i=1 i,0 qi,0 )
(p
Pn
(pi,t qi,0 )
= Pni=1
i=1 (pi,0 qi,0 )
Does chain calculation work for Paasche index?

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

A nice property of Laspeyres index:

Pn Pn Pn
i=1 (pi,t qi,0 ) i=1 (pi,t−1 qi,0 ) (pi,1 qi,0 )
PL,t|0 = n
P × n
P × ... × Pni=1 =
(p q
i=1 i,t−1 i,0 ) (p
i=1 i,t−2 i,0q ) i=1 i,0 qi,0 )
(p
Pn
(pi,t qi,0 )
= Pni=1
i=1 (pi,0 qi,0 )
Does chain calculation work for Paasche index?
Pn Pn Pn
i=1 (pi,t qi,t ) i=1 (pi,t−1 qi,t−1 ) (pi,1 qi,1 )
Pn × Pn × ... × Pi=1
n 6=
i=1 (pi,t−1 qi,t ) i=1 (pi,t−2 qi,t−1 ) i=1 (pi,0 qi,1 )
Pn
(pi,t qi,t )
6= Pni=1 = PP,t|0
i=1 i,0 qi,t )
(p

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics
Measuring Joblessness: The Unemployment Rate
The Household Survey
Employed: This category includes those who at the time of the
survey worked as paid employees, worked in their own business,
or worked as unpaid workers in a family members business. It
also includes those who were not working but who had jobs from
which they were temporarily absent because of, for example,
vacation, illness, or bad weather.
Unemployed: This category includes those who were not
employed, were available for work, and had tried to find
employment during the previous four weeks. It also includes those
waiting to be recalled to a job from which they had been laid off.
Not in the labor force: This category includes those who fit
neither of the first two categories, such as a full-time student,
homemaker, or retiree. A person who wants a job but has given
up lookinga discouraged workeris counted as not being in the
labor force.
Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries
The Data of Macroeconomics
Measuring Joblessness: The Unemployment Rate
The Household Survey
The labor force is defined as the sum of the employed and
unemployed, and the unemployment rate is defined as the
percentage of the labor force that is unemployed. That is,

Labor Force = Number of Employed + Number of Unemployed

Number of Unemployed
Unemployment Rate = × 100%
Labor Force
The labor-force participation rate is the percentage of the
adult population that is in the labor force:
Labor Force
Labor Force Participation Rate = × 100%
Adult Population
Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries
The Data of Macroeconomics

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries

The Data of Macroeconomics

Gayane Barseghyan Lectures 1-2: Macroeconomics: Preliminaries