Class 4

Recap of lectures, intro to

policies, exercises and
electronic search of data
Macroeconomics - is a study of the performance of national
economy and global economy
 Aggregate Demand (AD) – is the total demand in the
economy

C = households’ consumption
AD = C + I + G + (X- M) I = gross investments (including
changes in inventories)
Foreign Demand G = government consumption
Domestic Demand X = exports of goods and
services
Notes:
AD = GDP expenditure approach M = imposts of goods and
AD – refers to quantities demanded (Q) services
X- M = net exports
Aggregate Demand - AD is inversely related to prices – as
prices increase, less quantity is demanded
 Aggregate Supply (AS) – is the total
supply in the economy
Prices of factors of
AS - depends on the availability, production or inputs:
price and productivity of the factors • Labour – wage
of production: land, labor, capital • Capital – interest
and entrepreneurship • Land – rent
• Entrepreneurship –
profit

Notes:
AS refers to quantities supplied
 Aggregate Supply: on short and long run
Short-run AS – at higher prices firms are
willing to supply more of goods and services
(because the input prices are not completely
adjusted to changes in the price level of final
goods)
Long-run AS – is inelastic (vertical) it doesn’t
depend on price changes (input prices have
completely adjusted to changes in the price
level of final goods)
 Macroeconomic Equilibrium
• Equilibrium in the market - occurs when
the price balances the plans of buyers and
sellers
• The equilibrium price - is the price at
which the quantity demanded equals the
quantity supplied
• The equilibrium quantity – is the quantity
bought and sold at equilibrium price
• In macroeconomics - equilibrium is
where AD and AS intersect
• In equilibrium, the inflation rate (Π)
equates AD and AS at the level of output Y
Changes to the Macroeconomic Equilibrium
AS is constant (without
changes):
• If AD increases -
Inflationary boom
• If AD decrease -
Deflationary recession

AD is constant (without
changes):
• If AS increases -
Deflationary boom
• If AS decrease -
Inflationary recession
Key macroeconomic variables: GDP, Inflation, Unemployment,
Balance of Payments (BoP)
• GDP - is a measure of the total income, total expenditures and total
production of an economy.
• Inflation - refers to a situation in which the economy’s overall price
level is rising. The inflation rate is the percentage change in the price
level from the previous period.
• Unemployment - mmacroeconomic problem that affects people most
directly and severely (micro level). Unemployment or job loss mean
lower living standard and psychological distress.
• Balance of Payments (BoP) - measures the flows of goods and
services, income and financial flows between one country and rest of
the world
 Why study macroeconomics?
• Changes to AD and AS lead to changes in GDP and Inflation
• Changes in GDP and inflation ultimately lead to changes in unemployment and
BoP
• Governments are interested in management of each of these macroeconomic
variables
• Higher GDP can improve income levels across the economy
• Low and stable inflation is desirable for consumers and provide a preferable
investment environment for firms
• Decline in unemployment is connected with declining macro costs for
economy and micro aspects – better life for individuals
• BoP is connected with external country's position sustainability

As future business people – You need to understand the main

developments in domestic and global economy
 How do government control AD and
AS and thereby manage the economy?
Demand Side Policies:
• Fiscal Policy – is the use of
government spending and
taxation to influence the level of
aggregate demand in economy
• Monetary Policy – is the use of
interest rates, as well as supply
of money to financial sector, with
the aim of influencing the level of
aggregate demand in the
economy
Supply Side Policies :
• Given than aggregate supply is price
inelastic (vertical) on long – run;
• Thus, AS defines the equilibrium
level of GDP – full capacity of
factors’ of production
• On long run, growth in GDP and
low inflation can only occur with
an increase in AS
• How – through more factor inputs,
better productivity (education,
health..), innovations, technology etc.
GROSS DOMESIC PRODUCT (GDP)

MEASURMENT: NOMINAL VS. REAL GDP

• Production approach Real GDP ($) * GDP Deflator (index)
Nominal GDP ($) =
• Expenditure approach 100

• Income approach Real GDP ($) =

Nominal GDP ($)
100
GDP Deflator (index) *
Nominal GDP ($)
GDP Deflator (index) = 100
Real GDP ($) *

Economic growth rate (%) = Real GDPt+1 – Real GDPt * 100

Real GDPt
Exercises 1
1. Consider the following data on U.S. GDP:

GDP Deflator (base

Year Nominal GDP (in billions)
year 2000)
2008 9873 118
2007 9269 113

a. What was the growth rate of nominal GDP between 2007 and 2008? (Note:
the growth rate is the percentage change from one period to the next.)

b. What was the growth rate of the GDP deflator between 2007 and 2008?

c. What was real GDP in 2007 measured in 2000 prices?

Exercises 2
Below are data from the land of milk and honey.
Year Price of milk Quantity of milk Price of honey Quantity of honey
2006 1$ 100 2$ 50
2007 1 200 2 100
2008 2 200 4 100

1.Compute nominal GDP, real GDP and the GDP deflator for each
year, using 2006 as a base year.
2.Compute the percentage change in nominal GDP, real GDP and
GDP deflator in 2007 and 2008 from the preceding year. For each
year, identify the variable that does not change.
Exercises 3
One day, Berry the Barber, Inc. collects 400$ for haircuts. Of this 400$,
Barry pays 30$ to the government as sales tax, takes home 260$ as
wages, and retains 110$ in the business to add new equipment in future.
From the 260$ that Barry takes home, he pays 70$ as personal income
tax. Compute Barry’s contribution to the following measure of income:

• a. GDP
• b. government revenues
• c. disposable personal income.
Exercises 4
An economy’s nominal GDP (NGDP), RGDP, and GDP deflator data are
given as follows (in billions of $)
  2012 2013
NGDP 12 12.5
RGDP   10.4
GDP deflator 118  

a)  Fill in the blanks and show your work.

b)  Calculate the annual rate of growth of GDP from
2012 to 2013.
 INFLATION MEASURMENT – Consumer
Price Index (CPI):
1. Find the cost of the basket at
TYPES: base – period prices
• Demand Pull – a rise in
2. Find the cost of the basket at
aggregate demand
current – period prices
• Cost Push – a rise in
3. Calculate CPI for the base period
production costs
and current period
• Inflationary Expectations –
Cost of CPI basket at
beliefs about future price CPI = current-period prices
levels Cost of CPI basket at
* 100

base-period prices

The inflation rate is the percentage change in the InfIation rate (%) = (CPI this year - CPI last year) * 100
price index (CPI) from the preceding period.
CPI last year
Calculating the Consumer Price Index and the Inflation Rate: An Example

Copyright©2004 South-Western
Nominal vs. Real variables
Real salary = Nominal salary / Price index *100
Real salary – refers to real purchasing power

Real interest rate = Nominal interest rate – Inflation rate

*r = i − π i denotes the nominal interest rate,

r real interest rate, and
π the rate of inflation;
From here –
i = r + π - nominal interest rate is the sum of the real interest rate and the inflation rate
*The exact formula is (1 + r) = (1 + i)/(1 + π)
Exercises 5

Suppose expected inflation for next year is 2.5%.

a) If you are currently earning £28,000 a year, what should your
nominal wage be next year if you want to keep your real wage
constant?

b) Suppose the current tax allowance is £6,475. What should the

tax allowance be next year to avoid the problem of fiscal drag?
Exercises 6

Suppose you take out a mortgage of £100,000 with a fixed rate of

7% a year. The inflation rate is 3.5%.
A. What is the nominal profit the borrower (bank) is making?
B. What is the real profit the borrower is making?
C. What is the real rate you are paying?
D. Suppose the economy now enters into a deflation with prices going
down by 2% a year. How do your answers to the previous points
change?
Exercises 7
Fill in the table below
Nominal Real
Year CPI
wage wage
1980 100 $6/hour  
1990   $10/hour $8/hour
2000 150   $7/hour
Exercises 8

Suppose you earned $40,000 in 2013 and you want to know how
much your father would have had to earn during 1983 to have had the
same purchasing power as you had with your $40,000 income in
2013. The CPI in 1983 was 100 and in 2013 CPI was 210.
 Exercises 9
Jimmy is an avid candy consumer. Last year, he purchased 75 Snickers bars
costing $2 each and 100 Butterfinger bars costing $1 each. This year, he
purchased 120 Snickers bars for $1.50 each and 90 Butterfinger bars for $1.75
each.

• Assume that a typical consumer basket includes 50 bars of each type. Compute a
consumer price index for each year and determine the percentage change in the
index over the two years.  
• Calculate Jimmy's nominal spending on candy bars in each year. Does nominal
spending increase or decrease?
• Using the first year as the base year, determine Jimmy's real spending on candy
bars in each year. Does real spending increase or decrease?
• Calculate the implicit price deflator (defined as nominal spending divided by real
spending). How does this deflator compare the CPI calculated in part (a)? Which
measurement do you think is more relevant in determining the change in Jimmy's
cost of living?
UNEMPLOYMENT
MEASURMENT:
TYPES: Labour Force Survey
 Cyclical Working age population (WAP)
 Classical Employed (E)
 Frictional Unemployed (U)
 Structural Inactive

E+U = Labour Force (LF)

Unemployment rate = U/ LF *100
Participation rate = LF/ WAP*100
Employment rate = E/ WAP *100
Exercises 10

The State Statistical Office announced that of total working-age population

(aged 15-79) in Macedonia in 2010q3, that is 1,448,670, 640,852 were
employed, 300,138 were unemployed, and 507,681 were inactive.

A. How big was the labour force in Macedonia?

B. What were the participation, unemployment and employment rates?
Exercises 11

• The State Statistical Office announced that in 2010q3, (national

average) employment rate in Macedonia was 44% and participation
rate was 65%. In the same period, there the female working-age
population was 714,984, there were 252,318 employed females and
114,503 unemployed females.

A. Calculate the participation and employment rates for females.

B. Are they and how different from the national averages?
C. What are the reasons for the difference?