Macroecono

mics
Lionel Artige
1 – Introduction

2
Objectives
• Understand what economic information (concept, data, statistic) is.

• Understand what macroeconomic information is.

• Answer the question: is economics a science?

• Definitions and measurement.

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The economy: etymology

• “Economy” derives from Latin “oeconomia”, which itself

derives from Ancient Greek οἰκονομία (oikonomía,
“management of a household”).

• The word “oikonomía” is composed of two parts: οἶκος (oîkos,

“house”) and νέμω (némō, “allocate”).

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The economy: a definition

• The economy is a system for distributing limited resources (land, raw

materials, energy, labor, etc.) and creating wealth from these resources.

• What are the keywords?

“System”  a set of interdependent wishes and actions of individuals
“distributing”  an allocation mechanism
“limited”  scarcity
“wealth”  material well-being

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The market economy: a
definition
• A market economy is a decentralized economy. Decisions are made by
individuals within the limits set by law.

• Trades between individuals take place at market prices. These prices fluctuate
freely according to the law of supply and demand.

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Price
Demand Supply The equilibrium price and
quantity in a market
economy: A decentralized
process.

Demand is determined by the

individuals who want to buy
the good, and supply is
∗ determined by the individuals
𝑃 who want to sell it. If demand
and supply do not match, the
price will change up to the
point where demand equals
∗
𝑄 Quantity
supply. This is the law of
supply and demand.

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Price
Demand Supply In a centralized economy,
supply and price are set by
centralized authorities. The
equilibrium process is
bureaucratized.

Demand is determined by the

individuals who wish to buy
∗ the good. If supply does not
𝑃 match demand, there is a
Shortag shortage (queuing in stores).
e The equilibrium is reached if
the centralized supply
𝑠 𝑑
𝑄 𝑄 Quantity
(bureaucracy) processes well.

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 The market economy diagram

Labor force (labor supply)

Wage
Demand for
Households labor Entreprises
Sale of goods and services (supply of goods and
services)
Prices of goods and
services
Purchase of goods and services (demand for goods and
services)

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Market economy vs
centralized economy
• A market economy is demand-driven. Supply must adapt to demand.

• A centralized economy is supply-driven. Demand must adapt to supply.

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Economics: what is it?

• Economics is a social science that seeks to analyze and describe the

production, distribution, and consumption of wealth.

• The economist Jacob Viner: “Economics is what economists do”.

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Economics: is it a science?

• In the previous slide, I defined economics as a social science.

• Debate: do you agree that economics is a science?

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Economics: is it a science?

• Encyclopedia Britannica: “Science, any system of knowledge that is concerned

with the physical world and its phenomena and that entails unbiased
observations and systematic experimentation. In general, a science involves a
pursuit of knowledge covering general truths or the operations of fundamental
laws.”

• A science is not defined by its subject but by its method.

(Medicine in Molière's time was not scientific. Today, nobody disputes that
medicine is a scientific discipline. Medical researchers apply the scientific method
to produce knowledge.)

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Economics: is it a science?

• As a result, both scientific and non-scientific economics are possible.

• At university, economists must do scientific economics, i.e, they have to use

the scientific method.

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Scientific economics
• Scientific economists proceed by simplification. They study an economic
phenomenon by reducing it to a small number of interdependent relationships.
This theoretical representation is an abstraction of the reality under study.

• Since the second half of the 20th century, this theoretical representation has
often taken the form of a mathematical model.

• The explanatory and predictive powers of the model are then tested
empirically.

• Nowadays, economists’ methods are essentially quantitative (mathematical

models and statistics).

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Microeconomics and
macroeconomics
• Since the 1930s, economics comprises two branches: microeconomics and
macroeconomics.

• Microeconomics is the branch of economics that studies the economic

behavior of decision-making units. For example, the consumption behavior of a
household, the investment behavior of a firm, etc. These individual agents
make buying and selling decisions.

• Macroeconomics is the branch of economics that studies the economic

behavior of aggregates such as a group of agents (e.g. workers in the
pharmaceutical industry, firms in the retail sector) or a group of products (e.g.
energy expenditure in Belgium).

• Obviously, macroeconomics and microeconomics should be related and even 16

Macroeconomics
Why to aggregate?

• The national economy is made up of many individuals and firms. To get an

accurate picture of the national economy, you need aggregate statistics.

• The evolution of national aggregates is important information for individual

decisions. In enterprises and on the financial markets, the evolution of GDP or
inflation is closely scrutinized.

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Macroeconomics
Macroeconomics is itself divided into two branches:

• Economic growth (long-term macroeconomics)

• Business cycles (short-term macroeconomics)

Again, these two branches should be integrated.

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 Short-term and long-term
20
Macroeconomics
18 Long-term growth
16

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12

10

4 Business cycles

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Macroeconomics
Why two branches of Macroeconomics?

• Prices of goods and services are relatively sticky in the short run (while stock
prices are vey volatile).

• Prices of goods and services are flexible in the long run.

=> This difference is key because monetary policy will have short-run effects on
production and employment while, in the long run, monetary expansion only
generates inflation.

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The main macroeconomic
aggregates

• Gross Domestic Product (GDP) measures national production.

• Inflation measures the evolution of prices of goods and services.

• Unemployment measures the number of the jobless active population.

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How to measure production?
Question: How do you measure annual production in a country like Belgium?

To answer this question, we need to define the unit of measurement, the

accounting method, and the limits of the production set.

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How to measure production?
1) What unit of measurement?

Nothing could be simpler than to measure the output of a firm or the whole
economy producing a single good.

For example: Firm A produced 50 tons of flour in 2015. To measure this firm's
output, we need only consider the quantity produced, i.e. 50 tons.

If all the firms in our economy produce flour, then all we have to do is add up the
quantities produced in tons to get a measure of total production.

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How to measure production?
A serious problem arises when one or more firms produce different goods.

To measure total production, we need to "aggregate" all the products in some

way. But this aggregation is not self-evident, as the following example shows:

For example: next to Firm A, Firm B produces 10 tons of bread.

What is the measure of total production?

We could add up the tons of each of the two productions, i.e. 60 tons. But since the
goods are different, total tonnage may make sense logistically, but it doesn't make
much macroeconomic sense. Indeed, this would imply that 1 ton of flour and 1 ton
of bread are valued in the same way, even though economic agents may value
them differently.
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How to measure production?
To be able to aggregate all individual productions to obtain a single total production
quantity (called an aggregate), we need a common unit of measurement for all
productions.

This common unit of measurement is the monetary unit.

In our example, we could choose the euro. The monetary unit enables us to express
the price structure (all relative prices) of total production. It is the market, by
revealing demand and supply for each good and service, that gives the price
structure. These prices reveal the value of each good in relation to the value of all
the others. The market tells us the relative price of flour and bread. If a ton of flour
is worth 100 euros and a ton of bread is worth 1000 euros, then the relative price
of flour and bread is 1/10 (1 ton of flour is worth 100 kilos of bread, not 1 ton of
flour is worth 1 ton of bread as before). I can then compare flour and bread since I
have a common unit of measurement. 25
How to measure production?
Total production is then easy to measure: it's the monetary value of this production,
i.e. :

50 tons of flour × 100 euros + 10 tons of bread × 1,000 euros = 15,000 euros

Consequently, to measure a material quantity (production), we need to use a

unit of value as a common unit of measurement.

This may seem strange at first since we're interested in owning a house, ten shirts,
or twenty cans of beer, but not in their value. Nevertheless, as these are different
goods that we, collectively, do not value identically, the only way to compare them
is by using a unit of value as a unit of measurement.

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How to measure production?
2) Accounting method: production recorded in firm accounts or value added?

Firm A produced 50 tons of flour worth 5,000 euros and Firm B produced 10 tons of
bread worth 10,000 euros in 2005. Firm B bought 20 tons of flour from Firm A worth
2,000 euros in the same year. According to the accounts of both firms, total
production (the sum of Firm A's and Firm B's production) amounted to 15,000 euros
in 2005.

Is this really the value of total production?

Answer: NO

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How to measure production?
In fact, in this calculation based on firm accounts, the production of 20 tons of flour
worth 2,000 euros is counted twice: once in the accounts of Firm A and once in the
accounts of Firm B.

However, these 20 tons of flour were only produced once. Instead of remaining a
final consumption (definitive exit from the production process), they became an
intermediate consumption (used in B's production process) for Firm B.

The real output of our two-firm economy is 5,000 euros for Firm A and 8,000 (=
10,000 - 2,000) euros for Firm B. Total production = 13,000 euros.

To avoid double counting, we have removed intermediate consumption from Firm

B's accounts. To sum up, only Firm B's value added has been taken into account.

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How to measure production?
Note: if Firms A and B were to merge, then the output of the new single firm would
be 30 tons of flour worth 3,000 euros and 10 tons of bread worth 10,000 euros.
Total production = 13,000 euros.

The firm produced 50 tons of flour, but 20 tons were not sold on the market but
used in the bread production process. In the company's accounts, only the
production that was the subject of transactions appears, i.e. the equivalent of
13,000 euros. As there is only one firm, there is only one production process, so
there is no risk of counting the same production twice.

Consequently, to have an adequate measure of production, we need to measure

the value added achieved by productive economic agents.

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How to measure production?
3) Limits of the production set: which productions are taken into account?

We take into account the output of:

• firms,
• non-governmental organizations,
• public administrations,
• and households.

While it is easy to measure the output of firms, since they must record all
transactions in their accounts, it is much more difficult to measure the output of
public administrations and especially households, for whom there are no
accounting records of all their transactions and some of their output.

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How to measure production?
For example, household domestic production (cooking, cleaning, vegetable
gardening, DIY, etc.) is not taken into account when calculating output. Since there
are no transactions, prices, or accounting records of this production, it is impossible
to measure it. It is therefore disregarded. This underestimates total production.

The underground economy, by definition, is difficult to measure. We make do with

very rough estimates, which may underestimate or overestimate total production.

Police and other collective services enjoyed by all economic agents are counted
twice: once as government output, and a second time as intermediate consumption
in the accounts of other economic agents. Since we don't know how to price these
services, we can't subtract them from their accounts when calculating value added.
We therefore count them twice, which results in an overestimation of total
production.
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How to measure production?

• For all the mentioned reasons, it is impossible to calculate a country's

production exactly.

• The job of statisticians is therefore to give an estimate of a country's

production in a year.

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National accounting: GDP

• Gross Domestic Product (GDP) is the measure of production of goods and

services in a given geographical area (in general: nation).

• For instance, national GDP in 2022 is the level of production or income of a

country in 2022. In Belgium, GDP amounted to 552 billion euros in 2022.

• The GDP figure is a single number aggregating all the production of the
production units in Belgium. GDP is the main macroeconomic aggregate.

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Exercise

Quantity Price

Product 1 5 80

Product 2 150 4

Product 3 15 12

Product 4 54 7

Calculate the GDP of this economy. What can you conclude from your results?

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Exercise

Calculate the GDP of this economy. What can you conclude from your results?

GDP is the market value of production and is expressed in euros. Even if people are interested
in the materiality of products, the aggregation of production must go through product prices.

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National accounting: GDP
There are 3 approaches to calculating GDP:

• The production approach: the sum of gross value added

• The expenditure approach: the sum of all final consumption expenditures

• The income approach: the sum of all incomes

The National Accounts Institutes calculate GDP from the expenditure approach. The
other two approaches allow us to confirm the results since

At the national level: Production = Income = Consumption

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National accounting: GDP
If you want to measure the economic power of a country

=> Use national GDP

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National accounting: GDP
If you want to measure the living standard in a country

=> Use

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National accounting: GDP
If you want to compare the living standards across countries

=> Use GDP per capita in Purchasing Power Parity (PPP) = GDP

where is the PPP exchange rate between the domestic currency and the US dollar.

When we want to compare the GDPs of different countries with different currencies,
we need to convert these GDPs into the same currency (usually the US dollar). To
do this, we use market exchange rates. The problem is that these exchange rates
reflect productivity differences between countries rather poorly, and modify the
relative price structures of countries that don't use the dollar. To solve this problem,
we use PPP exchange rates, which preserve relative price structures. To do this, we
need to use a basket of goods common to all countries, since different countries
may consume different products. 39