CHAPTER 1:

INTRODUCTION TO
MACROECONOMICS
LECTURED BY: JASON PEOU, MFIN (MELB)
 CONTENT
• 1. What Macroeconomists Study
• 2. How Economists Think
• 3. Measuring the Value of Economic Activity
• 4. Rules for Computing GDP
• 5. Real GDP Versus Nominal GDP
• 6. The GDP Deflator
• 7. The Components of Expenditure
• 8. Other Measures of Income
• 9. Measuring the Cost of Living
• 10. CPI versus GDP Deflator
• 11. Measuring Joblessness

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1. WHAT MACROECONOMISTS STUDY

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1. WHAT MACROECONOMISTS STUDY

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1. WHAT MACROECONOMISTS STUDY

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 1. WHAT MACROECONOMISTS STUDY
• Macroeconomics attempts to answer economic events that touch each of our lives.
• Macroeconomic issues play a central role in national politics.
• Macroeconomic issues are also central to world politics.
• While the job of crafting economic policy belongs to world leaders, the job of explaining the
workings of the economy as a whole falls to macroeconomists.
• To be sure, macroeconomics is an imperfect science.
• Every era has its own economic problems, and policymakers must respond to the
challenges they face.
• Macroeconomic history is not a simple story, but it provides a rich motivation for
macroeconomic theory.
• Economists study politically charged issues, but they try to address these issues with a
scientist’s objectivity.

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 2. HOW ECONOMISTS THINK
• Theory as Model Building
• Economists also use models to understand the world.
• An economist’s model is often in mathematical terms, which is made of symbols and
equations, to show the relationships among the variables.
• The model illustrates the essence of the object it is designed to resemble.
• Models are useful because they help us dispense with irrelevant details and focus on
underlying connections.

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 2. HOW ECONOMISTS THINK
• The Use of Multiple Models
• Macroeconomists study many facets of the economy.
• Economists use models to address all these issues, but no single model can answer
every question.
• Students of macroeconomics must keep in mind that there is no single “correct” model
that answers every economic question.
• Instead, there are many models, each of which is useful for shedding light on a facet of
the economy.
• Remember that a model is only as good as its assumptions and that an assumption that
is useful for some purposes may be misleading for others.

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 2. HOW ECONOMISTS THINK
• Prices: Flexible Versus Sticky
• Economists normally presume that the price of a good or a service moves quickly to
bring quantity supplied and quantity demanded into balance: market clearing.
• The assumption of continuous market clearing, however, is not entirely realistic.
• For markets to clear continuously, prices must adjust instantly to changes in supply
and demand: price flexibility.
• In fact, many wages and prices adjust slowly: price stickiness.
• Therefore, most macroeconomists believe that price flexibility is a good assumption for
studying long-run issues.
• For studying short-run issues, most macroeconomists believe that price stickiness is a
better assumption for studying the short-run behavior of the economy.

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 3. MEASURING THE VALUE OF ECONOMIC ACTIVITY
• Gross domestic product, or GDP, is often considered the best measure of how well an
economy is performing.
• The purpose of GDP is to summarize all these data with a single number representing the
dollar value of economic activity in a given period of time.
• There are two ways to view this statistic.
• One way to view GDP is as the total income of everyone in the economy.
• The other is as the total expenditure on the economy’s output of goods and services.
• How can GDP measure the economy’s income and its expenditure on output at the same
time? It can do so because these two quantities are really the same.
• To understand the meaning of GDP more fully, we turn to national income accounting, the
system used to measure GDP and many related statistics.

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 3. MEASURING THE VALUE OF ECONOMIC ACTIVITY
• Income, Expenditure, and the Circular

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 3. MEASURING THE VALUE OF ECONOMIC ACTIVITY
• Stocks and Flows

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 3. MEASURING THE VALUE OF ECONOMIC ACTIVITY
• Gross domestic product (GDP) is the market value of all final goods and services produced
within an economy in a given period of time.
• Suppose, for example, that the economy produces four apples and three oranges. How do
we compute GDP?
• To compute the total value of different goods and services, the national income accounts
use market prices because these prices reflect how much people are willing to pay for a
good or service. Thus, if apples cost $0.50 each and oranges cost $1.00 each, GDP would be:

• It is not surprising that real GDP follows a seasonal cycle. Some of these changes are
attributable to changes in our ability to produce.

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 4. RULES FOR COMPUTING GDP
• Used Goods
• The sale of used goods is not included in GDP because GDP measures the value of
currently produced goods and services.
• Inventories
• Production for inventory increases GDP just as much as production for final sale does
because this investment in inventory is counted as expenditure by the firm owners.
• Intermediate Goods
• GDP includes only the value of final goods.
• Imputations
• When computing GDP, some are not sold in the marketplace and therefore we must use
an estimate of their value: imputed value.

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 5. REAL GDP VERSUS NOMINAL GDP
• Economists call the value of goods and services measured at current prices nominal GDP.
Notice that nominal GDP can increase either because prices rise or because quantities rise.

• Economists use real GDP, which measures the value of goods and services using a constant
set of prices. That is, real GDP shows what would have happened to expenditure on output if
quantities had changed but prices had not.

• Because a society’s ability to provide economic satisfaction for its members ultimately
depends on the quantities of goods and services produced, real GDP provides a better
measure of economic well-being than does nominal GDP.

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 6. THE GDP DEFLATOR
• Using nominal GDP and real GDP, we can compute a third statistic: GDP deflator.
• The GDP deflator, also called the implicit price deflator for GDP, is the ratio of nominal GDP
to real GDP:

• The definition of the GDP deflator allows us to decompose nominal GDP into two parts: one
part that measures quantities (real GDP) and another that measures prices (the GDP
deflator). That is:

• We can also write this equation as:

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 7. THE COMPONENTS OF EXPENDITURE
• The national income accounts divide GDP (Y) into four broad categories of spending:
• Consumption (C) consists of household expenditures on goods and services.
• Investment (I) consists of items bought for future use. Investment is divided into three
subcategories: business fixed investment, residential fixed investment, and inventory
investment.
• Government purchases (G) are the goods and services bought by federal, state, and
local governments. It does not include transfer payments to individuals.
• Net exports (NX) are the value of goods and services sold to other countries (exports –
X) minus the value of goods and services that other countries sell to us (imports – M).
• Equation:
• This equation is an identity — an equation that must hold because of the way the variables
are defined. It is called the national income accounts identity.

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 8. OTHER MEASURES OF INCOME
• Gross National Product (GNP)
• GNP = GDP + Factor Income from Abroad – Factor Income to Abroad
• Net National Product (NNP) = GNP – Depreciation
• National Income (NI) = NNP – Statistical Discrepancy
• NI = Compensation of Employees + Proprietors’ Income + Rental Income
+ Corporate Profits + Net Interests + Taxes on Production and Imports
• Personal Income (PI)
• PI = (NI – Indirect Business Taxes) + (Dividends – Corporate Profits)
+ (Government Transfers to Individuals – Social Insurance Contributions)
+ (Personal Interest Income – Net Interest)
• Disposable Personal Income (DPI) = Personal Income − Personal Taxes

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 9. MEASURING THE COST OF LIVING
• The Price of a Basket of Goods
• The most commonly used measure of the level of prices is the consumer price index
(CPI), which is the price of this basket of goods and services, purchased by a typical
consumer, relative to the price of the same basket in some base year.
σ 𝑄𝑖 ×𝑃𝑖𝐶𝑢𝑟𝑟𝑒𝑛𝑡
• 𝐶𝑃𝐼 = σ 𝑄𝑖 ×𝑃𝑖𝐵𝑎𝑠𝑒
• Another is the producer price index (PPI), which gauges inflation from the perspective
of sellers.
• In addition to these aggregate price indexes, the BLS computes price indexes for
specific types of goods, such as food, housing, and energy.
• Another statistic, sometimes called core inflation, measures the increase in price of a
consumer basket that excludes food and energy products.

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 10. CPI VERSUS GDP DEFLATOR
• The first difference is that the GDP deflator measures the prices of all goods and services
produced, whereas the CPI measures the prices of only the goods and services bought by
consumers.
• The second difference is that the GDP deflator includes only those goods produced
domestically. Imported goods are not part of GDP and do not show up in the GDP deflator.
• The third and most subtle difference is that the CPI assigns fixed weights to the prices of
different goods, whereas the GDP deflator assigns changing weights.
• Economists call a price index with a fixed basket of goods a Laspeyres index, which
tends to overstate the increase in the cost of living that results from substitution bias
and a price index with a changing basket a Paasche index, which tends to understate
the increase in the cost of living.
• CPI is a closely watched measure of inflation though it is subject to 3 major problems:
substitution bias, introduction of new goods and unmeasured changes in quality.

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 11. MEASURING JOBLESSNESS
• The labor force is the sum of the employed and unemployed.

• Unemployment rate is the percentage of the labor force that is unemployed.

• Labor-force participation rate is the percentage of the adult population that is in the labor
force.

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11. MEASURING JOBLESSNESS

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 11. MEASURING JOBLESSNESS
• The Household Survey
• The unemployment rate comes from a survey of about 60,000 households called the
Current Population Survey. These households include about 110,000 individuals.
• Based on the responses to survey questions, each adult (age 16 and older) is placed into
one of three categories: employed, unemployed and not in the labor force.
• Notice that a person who wants a job but has given up looking — a discouraged worker
— is counted as not being in the labor force.
• The Establishment Survey
• The unemployment rate come from a separate survey of about 145,000 businesses and
government agencies, representing about 700,000 worksites.
• When you read a headline that says the economy created a certain number of jobs last
month, that statistic is the change in the number of workers that employers have on
their payrolls.
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 CONCLUSION
• The three statistics discussed in this chapter — gross domestic product, the consumer price
index, and the unemployment rate — measure the performance of the economy.
• Public and private decisionmakers use these statistics to monitor changes in the economy
and to formulate appropriate policies.
• Economists use these statistics to develop and test theories about how the economy works.
• In the chapters that follow, we examine some of these theories. That is, we build models
that explain how these variables are determined and how economic policy affects them.
• Having learned how to measure economic performance, we are now ready to learn how to
explain it.

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