Macroeconomics: main topics

Orusova O.V.
Economic Theory Department
 Основная литература
• Paul Krugman. Microeconomics.
• Paul Krugman. Macroeconomics.
• Olivier Blanchard. Macroeconomics
 17. Circular-Flow model of goods and
incomes in open economy
• Almost all countries calculate a set of numbers
known as the national income and product
accounts.
• The national income and product accounts, or
national accounts, keep track of the flows of
money between different parts of the
economy.
 An Expanded Circular-Flow Diagram
Government purchases of
goods and services Government borrowing
Government

Consumer spending Government transfers Private savings

Taxes

Households

Wages, profit, interest, rent

Markets for goods

and services Factor Markets Financial Markets

Wages, profit,
interest, rent Borrowing and
GDP
stock issues by
firms
Firms

Exports Foreign borrowing

and sales of stock
Rest of the world
Imports Foreign lending and purchases of stock
 18. Gross Domestic Product
• Gross domestic product or GDP measures the total
value of all final goods and services produced in the
economy during a given year. It does not include the
value of intermediate goods.

• Aggregate spending, the sum of consumer spending,

investment spending government purchases of goods
an services, and exports minus imports, I the total
spending on domestically produce final goods and
services in the economy.
Calculating Gross Domestic Product
• GDP can be calculated three ways:
– Add up the value added of all producers
– Add up all spending on domestically-produced
final goods and services. This results in the
equation: GDP = C + I + G + X - IM
– Add up all income paid to factors of production
 Three ways of measuring GDP
• Production Method: Measure the Value Added
summed across all firms (value added = sale price less
cost of raw materials)
• Expenditure Method: Spending by consumers (C) +
Spending by businesses (I) + Spending by government
(G) + Net Spending by foreign sector (NX)
• Income Method: Labor Income (wages/salary) +
Capital Income (rent, interest, dividends, profits)+
Government Income (taxes)
• Fundamental identity of national income account:
total production = total income = total expenditure
 19. Real vs. Nominal GDP
• Real GDP is the total value of the final goods
and services produced in the economy during a
given year, calculated using the prices of a
selected base year.

• Nominal GDP is the value of all final goods and

services produced in the economy during a
given year, calculated using the prices current in
the year in which the output is produced.
 GDP versus GNP
“Domestic” production or GDP measures the value of the
goods and services that are produced within the
geographic area of the country..It includes those goods
and services that are produced by foreigners within the
geographic limits of the country.
GDP=C+I+G+NX.
“National” production or GNP measures the production
of national citizens no matter where it takes place.
• To transform the measurement of the GDP into the
measure of GNP, it is necessary to add the net factor
income (NFI).
 GDP versus GNP
• The net factor income (NFI) is the income earned by
factors of production (labor, land and capital)
owned by national citizens in the rest of the world
and subtract the income earned by factors of
production owned by foreigners in the national
territory.
• Thus, the net factor income (NFI) from the rest of
the world must be added to obtain,
GNP=GDP+NFI=C+I+G+NX+NFI
 Other National Accounts Definitions:
• Net Domestic Product (NDP) equals GDP minus
Depreciation
• National Income (NI) equals NDP plus Net American
Income Abroad minus Indirect Business Taxes.
• Personal Income (PI) equals NI minus Social Security
Contributions minus Corporate Income Taxes minus
Undistributed Corporate Profit plus Transfer Payments
• Disposable Income (DI) equals PI minus Personal
Taxes
 Other National Accounts Definitions:

• DI = C + S
• Disposable Income is equal to the income
used to spend for goods and service and the
income used to save
 Price Indexes and the Aggregate Price Level

• The aggregate price level is a measure of the

overall level of prices in the economy.
• To measure the aggregate price level,
economists calculate the cost of purchasing a
market basket.
• A price index is the ratio of the current cost of
that market basket to the cost in a base year,
multiplied by 100.
 Inflation Rate, CPI, and other Indexes

• The inflation rate is the yearly percentage

change in a price index, typically based upon
Consumer Price Index, or CPI, the most
common measure of the aggregate price level.
• The consumer price index, or CPI, measures
the cost of the market basket of a typical
urban American family.
 The Consumer Price Index(CPI)
It measures the average level of prices in a basket
of goods and services (it does not include all the
goods and services produced as the GDP deflator
does).
There is a base year in which the quantities of
goods and services are recorded and priced.
The same basket (same quantities and same mix of
goods) is then priced in subsequent periods.
Observe that the CPI in the base year is 1.
 Other Price Measures
• A similar index to CPI for goods purchased by firms is the
producer price index.
• Economists also use the GDP deflator, which measures the
price level by calculating the ratio of nominal to real GDP.
• The GDP deflator for a given year is 100 times the ratio of
nominal GDP to real GDP in that year.
• The CPI has the following advantage: It is available at a
higher frequency (monthly or weekly). This is because only a
subset of goods and services are included, which makes
easier to monitor the evolution of prices frequently.
 20. Aggregate Demand
• The aggregate demand curve shows the
relationship between the aggregate price level
and the quantity of aggregate output
demanded by households, businesses, the
government and the rest of the world.
 The Aggregate Demand Curve
Aggregate price
level (GDP deflator,
2000 = 100)

A movement down the

AD curve leads to a
lower
aggregate price level and
1933 higher aggregate output.
8.9

5.0

Aggregate demand
curve, AD

0 636 950 Real GDP (billions of

2000 dollars)
 The Aggregate Demand Curve
• It is downward-sloping for two reasons:
– The first is the wealth effect of a change in the
aggregate price level—a higher aggregate price level
reduces the purchasing power of households’ wealth
and reduces consumer spending.
– The second is the interest rate effect of a change in
aggregate the price level—a higher aggregate price
level reduces the purchasing power of households’
money holdings, leading to a rise in interest rates and
a fall in investment spending and consumer spending.
 Shifts of the Aggregate Demand Curve

• The aggregate demand curve shifts because

of:
– changes in expectations
– wealth
– the stock of physical capital
– government policies
• fiscal policy
• monetary policy
 21. Aggregate Supply
• The aggregate supply curve shows the
relationship between the aggregate price level
and the quantity of aggregate output in the
economy.
 The Short-Run Aggregate Supply Curve

• The short-run aggregate supply curve is upward-

sloping because nominal wages are sticky in the short
run:
– a higher aggregate price level leads to higher profits and
increased aggregate output in the short run.
• The nominal wage is the dollar amount of the wage
paid.
• Sticky wages are nominal wages that are slow to fall
even in the face of high unemployment and slow to
rise even in the face of labor shortages.
 The Short-Run Aggregate Supply Curve
Aggregate price
level (GDP deflator,
2000 = 100)
Short-run aggregate
supply curve, SRAS

11.9
1929

8.9 A movement down

1933 the SRAS curve leads
to deflation and lower
aggregate output.

0 636 865 Real GDP (billions of

2000 dollars)
 Shifts of the Short-Run Aggregate Supply Curve

• Changes in
– commodity prices
– nominal wages
– productivity
• lead to changes in producers’ profits and shift
the short-run aggregate supply curve.
 Long-Run Aggregate Supply Curve
• The long-run aggregate supply curve shows
the relationship between the aggregate price
level and the quantity of aggregate output
supplied that would exist if all prices, including
nominal wages, were fully flexible.
 Long-Run Aggregate Supply Curve
Aggregate price Long-run aggregate
level (GDP deflator, supply curve, LRAS
2000 = 100)
15.0
…leaves the quantity
A fall in the of aggregate output
aggregate supplied unchanged
price level… in the long run.

7.5

0 $800 Real GDP (billions of

Potential
output, YP 2000 dollars)
 From the Short Run to the Long Run
(a) Leftward Shift of the Short-Run (b) Rightward Shift of the Short-Run
Aggregate Supply Curve Aggregate Supply Curve

Aggregate Aggregate
price level price level
LRAS LRAS SRAS1
SRAS2

SRAS2
SRAS1

A1 A1 A fall in nominal
P1 P
1
wages shifts SRAS
rightward.
A rise in nominal
wages shifts SRAS
leftward.

YP Y1 Y1 YP
Real GDP Real GDP
 22. The AS–AD Model
• The AS-AD model uses the aggregate supply
curve and the aggregate demand curve
together to analyze economic fluctuations.
 Short-Run Macroeconomic Equilibrium
• The economy is in short-run macroeconomic
equilibrium when the quantity of aggregate output
supplied is equal to the quantity demanded.
• The short-run equilibrium aggregate price level is
the aggregate price level in the short-run
macroeconomic equilibrium.
• Short-run equilibrium aggregate output is the
quantity of aggregate output produced in the short-
run macroeconomic equilibrium.
Aggregate price level The AS–AD Model
SRAS

P E Short-run
E SR macroeconomic
equilibrium

AD

Y Real GDP
E
 Shifts of Aggregate Demand: Short-Run Effects
(a) A Negative Demand Shock (b) A Positive Demand Shock

Aggregate price level Aggregate price level

A negative demand A positive demand
shock... shock...

SRAS SRAS

P ...leads to a higher
1 E P E
1 2 2 aggregate price
...leads to a lower
P P level and higher
2 E aggregate price level 1 E
2 1 aggregate output.
and lower aggregate
AD output. AD
1 2
AD AD
2 1
Y Y Y Y
2 1 1 2
Real GDP Real GDP
 Shifts of the SRAS Curve
(a) A Negative Supply Shock (a) A Positive Supply Shock

Aggregate Aggregate
price level price level
A negative supply A positive supply
shock... shock...

SRAS SRAS
2 SRA 1 1 SRA 2
E2 S E S
1
P P
2 1
...leads to a lower ...leads to a higher
P E1 aggregate output P E2 aggregate output
1 2
and a higher and lower
AD aggregate price AD aggregate price
level. level.

Y Y1 Y Y2
2 Real GDP 1 Real GDP
 Long-Run Macroeconomic Equilibrium

• The economy is in long-run macroeconomic

equilibrium when the point of short-run
macroeconomic equilibrium is on the long-run
aggregate supply curve.
 Long-Run Macroeconomic Equilibrium
Aggregate
price level
LRAS

SRAS

P E Long-run macroeconomic
E LR
equilibrium

AD

Y
P Real GDP
Potential output
 Short-Run Versus Long-Run Effects of a Negative
2. …reduces the aggregate
Aggregate Demand Shock
price level and aggregate
price level output and leads to higher
unemployment in the short
run… LRAS
SRAS
1

SRAS
2

P E
1 1
1. An initial
P2 negative 3. …until an eventual
demand shock… E fall in nominal wages
2
in the long run increases
P3 E short-run aggregate supply
3 AD
1 and moves the economy
AD back to potential output.
2

Y Y Potential
2 1 Real GDP
output
Recessionary gap
 Short-Run Versus Long-Run 3.Effects of a Positive
…until an eventual rise in nominal
Aggregate Demand Shock
wages in the long run reduces short-
price level run
1.An initial positive aggregate supply and moves the
demand shock… LRAS economy back to potential output.
SRAS
2

SRAS
1
E
3
P
3

P E 2. …increases the
2 E1 2
aggregate price level
P and aggregate output
1
AD
2 and reduces unemployment
AD in the short run…
1

Potential Y Y Real GDP

1 2
output
Inflationary gap
 Gap Recap
• There is a recessionary gap when aggregate
output is below potential output.
• There is an inflationary gap when aggregate
output is above potential output.
• The output gap is the percentage difference
between actual aggregate output and
potential output.
 22. Consumer Spending
• The consumption function is an equation
showing how an individual household’s
consumer spending varies with the
household’s current disposable income.
 Aggregate Consumption Function
• The aggregate consumption function is the
relationship for the economy as a whole
between aggregate current disposable income
and aggregate consumer spending.
Aggregate Consumption Function
 Investment Spending
• Planned investment spending is the
investment spending that businesses plan to
undertake during a given period.
• It depends negatively on:
interest rate
existing production capacity
• and positively on:
expected future real GDP.
 Savings and Investment Spending

• According to the savings–investment spending

identity, savings and investment spending are
always equal for the economy as a whole.
• The budget surplus is the difference between
tax revenue and government spending when tax
revenue exceeds government spending.
• The budget deficit is the difference between tax
revenue and government spending when
government spending exceeds tax revenue.
 Matching Up Savings and Investment Spending

• The budget balance is the difference between

tax revenue and government spending.
• National savings, the sum of private savings
plus the budget balance, is the total amount
of savings generated within the economy.
• Capital inflow is the net inflow of funds into a
country.
Investment versus investment spending
• When macroeconomists use the term investment spending,
they almost always mean “spending on new physical capital.”
This can be confusing, because in ordinary life we often say
that someone who buys stocks or purchases an existing
building is “investing.”
• The important point to keep in mind is that only spending that
adds to the economy’s stock of physical capital is “investment
spending.” In contrast, the act of purchasing an asset such as a
share of stock, a bond, or existing real estate is “making an
investment.”
 The Savings–Investment Spending Identity

• Investment spending = National savings +

Capital inflow in an open economy
• I = SPrivate + SGovernment + (IM − X) = NS + KI
 The Market for Loanable Funds
• The loanable funds market is a hypothetical
market that examines the market outcome of
the demand for funds generated by borrowers
and the supply of funds provided by lenders.
• The interest rate is the price, calculated as a
percentage of the amount borrowed, charged
by the lender to a borrower for the use of
their savings for one year.
 The Market for Loanable Funds
• The rate of return on a project is the profit
earned on the project expressed as a
percentage of its cost.
 The Demand for Loanable Funds
Interest
rate

A
12%

B
4

Demand for loanable funds, D

0 $150 450 Quantity of loanable funds

(billions of dollars)
 The
Interest
Supply for Loanable Funds
rate

Supply of loanable funds, S

12%
Y

4
X

0 $150 450 Quantity of loanable funds

(billions of dollars)
 Equilibrium
Interest
in the Loanable Funds Market
rate

Projects with rate of

return
8% or greater are funded.
12%
Offers not accepted from
lenders who demand interest
rate of more than 8%.
r* 8
Projects with rate of return
less than 8% are not funded.

Offers accepted from lenders

willing to lend at interest rate
0 of 8% or less.
$300 Quantity of loanable funds
Q* (billions of dollars)
 Shifts of the Demand for Loanable Funds

• Factors that can cause the demand curve for

loanable funds to shift include:
– Changes in perceived business opportunities
– Changes in the government’s borrowing

• Crowding out occurs when a government

deficit drives up the interest rate and leads to
reduced investment spending.
 An Increase in the Demand for Loanable Funds
Interest
rate

An increase in the
r demand for
. . . leads to a 2 loanable funds . . .
rise in the
equilibrium r
interest rate. 1

D
2

D
1

Quantity of loanable funds

 Shifts of the Supply for Loanable Funds
• Factors that can cause the supply of loanable funds
to shift include:
– Changes in private savings behavior: Between 2000 and
2006 rising home prices in the United States made many
homeowners feel richer, making them willing to spend
more and save less This shifted the supply of loanable
funds to the left.
– Changes in capital inflows: The U.S. has received large
capital inflows in recent years, with much of the money
coming from China and the Middle East. Those inflows
helped fuel a big increase in residential investment
spending from 2003 to 2006. As a result of the worldwide
slump, those inflows began to trail off in 2008.
 An Increase in the Supply of Loanable Funds
Interest
rate

S
1
S
2

r
. . . leads to a fall 1
in the equilibrium An increase in the
interest rate. supply for loanable
r
2 funds . . .

Quantity of loanable funds

 23. The Sources of Long-Run Growth
• Labor productivity, often referred to simply as
productivity, is output per worker.
• Physical capital consists of human-made
resources such as buildings and machines.
• Human capital is the improvement in labor
created by the education and knowledge
embodied in the workforce.
• Technology is the technical means for the
production of goods and services.
 Growth Rates
 The Rule of 70 tells us that the time it takes a variable
that grows gradually over time to double is
approximately 70 divided by that variable’s annual
growth rate.
 Accounting for Growth:
The Aggregate Production Function

 The aggregate production function is a hypothetical

function that shows how productivity (real GDP per
worker) depends on the quantities of physical capital
per worker and human capital per worker as well as the
state of technology.
 Diminishing Returns to Physical Capital
 An aggregate production function exhibits diminishing
returns to physical capital when, holding the amount of
human capital and the state of technology fixed, each
successive increase in the amount of physical capital
leads to a smaller increase in productivity.
 Physical Capital and Productivity
Real GDP
per worker

$60,000
1. The increase in
C
real GDP per 50,000
worker becomes B
smaller . . . 30,000
A

0
$20,000 50,000 80,000
Physical capital
2. as physical per worker
capital per worker (2000 dollars)
rises…
•
Growth Accounting
Growth accounting estimates the contribution of
each major factor in the aggregate production
function to economic growth.
• The amount of physical capital per worker grows 3% a
year.
• According to estimates of the aggregate production
function, each 1% rise in physical capital per worker,
holding human capital and technology constant,
raises output per worker by 1⁄3 of 1%, or 0.33%.
• Total factor productivity is the amount of output that
can be achieved with a given amount of factor inputs.
 Technological Progress and Productivity Growth
Real GDP per worker
(2000 dollars)
$120,000

90,000 Rising total factor

productivity shifts
curve up

60,000

30,000

0 $20,000 50,000 80,000 100,000

Physical capital
per worker
(2000 dollars)
 Why Growth Rates Differ
• A number of factors influence differences among
countries in their growth rates.
• These are government policies and institutions that alter:
– savings and investment spending.
– foreign investment.
– education.
– Infrastructure.
– research and development.
– political stability.
– the protection of property rights.
 The Role of Government in Promoting Economic
Growth

• Political stability and protection of property rights

are crucial ingredients in long-run economic growth.
• Even when governments aren’t corrupt, excessive
government intervention can be a brake on
economic growth.
• If large parts of the economy are supported by
government subsidies, protected from imports, or
otherwise insulated from competition, productivity
tends to suffer because of a lack of incentives.
 24. Unemployment Rate
• Employment is the number of people
currently employed in the economy, either full
time or part time.
• Unemployment is the number of people who
are actively looking for work but aren’t
currently employed.
• The labor force is equal to the sum of
employment and unemployment.
 Unemployment Rate

• The labor force participation rate is the

percentage of the population aged 16 or older
that is in the labor force.

 The unemployment rate is the percentage of the total

number of people in the labor force who are
unemployed.
 Unemployment Rate
• Discouraged workers are nonworking people who
are capable of working but have given up looking
for a job given the state of the job market.
• Marginally attached workers would like to be
employed and have looked for a job in the recent
past but are not currently looking for work.
• Underemployment is the number of people who
work part time because they cannot find full-time
jobs.
 The Nature of Unemployment
• Workers who spend time looking for
employment are engaged in job search.
• Frictional unemployment is unemployment
due to the time workers spend in job search.
• Structural unemployment is unemployment
that results when there are more people
seeking jobs in a labor market than there are
jobs available at the current wage.
 Structural Unemployment
The Effect of a Minimum Wage on the Labor Market
Wage
Rate Structural
unemployment

W
F

Minimum
wage
W
E

QD QE QS Quantity of Labor
 Structural Unemployment
• Minimum wages - a government-mandated
floor on the price of labor. In the U.S., the
national minimum wage in 2005 was $5.15 an
hour.
• Unions - by bargaining for all a firm’s workers
collectively (collective bargaining), unions can
often win higher wages from employers than
the market would have otherwise provided
when workers bargained individually.
 Structural Unemployment
• Efficiency wages - wages that employers set
above the equilibrium wage rate as an
incentive for better performance.

• Side effects of government policies - public

policies designed to help workers who lose
their jobs; these policies can lead to structural
unemployment as an unintended side effect.
 The Natural Rate of Unemployment

• The natural rate of unemployment is the

normal unemployment rate around which the
actual unemployment rate fluctuates. It is the
unemployment rate that arises from the
effects of frictional plus structural
unemployment.
• Cyclical unemployment is a deviation in the
actual rate of unemployment from the natural
rate.
 The Natural Rate of Unemployment

• Natural unemployment = Frictional

unemployment + Structural unemployment

• Actual unemployment = Natural

unemployment + Cyclical unemployment
 Productive extranalities
GDP gap
Okun’s law:
Y - Y*
= - (u - u*)
Y*
- Okun’s koefficient ( 2,5 - 3)
Y – actual GDP
Y* - potential GDP
u – actual unemployment rate
u*- natural unemployment rate
75