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College aantekeningen Macroeconomics: A European Perspective (ECB1MACR)
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Macroeconomics – everythingMacroeconomics, A European Perspective – Week 1 (Unit 13)
Fluctuations in the total output of a nation (GDP) affect unemployment, and unemployment
is a serious hardship for people.
Economists measure the size of the economy using the national accounts: these measure
economic fluctuations and growth.
Households respond to shocks by saving, borrowing, and sharing to smooth their
consumption of goods and services.
Due to limits on people’s ability to borrow (credit constraints) and their weakness of will,
these strategies are not sufficient to eliminate shocks to their consumption.
Investment spending by firms (on capital goods) and households (on new housing) fluctuates
more than consumption.
I. Introduction to macroeconomics
What is macroeconomics?
Economics: domain concerned with the production, use and management of resources
Macro: as a whole (from the Greek ‘makro’ which means large)
Societal relevance might be larger
Macroeconomic choices shape society as a whole
Differences with microeconomics
Emergent properties
o Property that is present when you have something in large quantities, but not in
small quantities
o Require interaction
o Example: inflation and consumer confidence require many transactions
General equilibrium effects
o Individual behaviour affects the price level
o The price level is an input for individual behaviour
o Example: If your income doubles, can you buy a bigger house? vs. If all incomes
double, can you buy a bigger house?
Economy-wide factors
o Economic sectors
o Government
o Central bank
Short-run macro Long-run macro
Involves the business cycle (4-7 years) Most other macro has a longer time frame
Dominates economic news and short-term Important for understanding the structure of
policy making the economy
Key elements: Key elements:
Shocks and policy (monetary, fiscal) Changes in institutions, technology and
affect the economy incentives affect the structure of the
The economy returns towards well- economy
defined equilibrium No well-defined equilibrium
Macro policy is about smoothing (short-run)
a. Idiosyncratic shocks
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, Affect only one household/firm
Example: new job/job loss, accident, winning the lottery
Are not macro-relevant
b. Economy wide shocks
Affect everyone
Example: inflation, fall/increase house prices, stock market crash/boom
Are macro-relevant, input for macro-policy
II. Macroeconomic models
What is an economic model?
A simplified description of reality that allows for analysis of a usually complicated issue. A model is
not a correct representation of reality. Yet, model provides insights.
Goals of models
Positive goals: Understanding, Validation, forecasting
Normative goals: Policy options (counterfactual analysis)
Traditions in macro-modelling
1. Large-scale macroeconomic models
2. Small theoretical model
3. Empirical work
4. Agent based models
Correlation may not be causation
Correlation: A statistical association in which knowing the value of one variable provides
information on the likely value of the other, for example high values of one variable being
commonly observed along with high values of the other variable. It can be positive or
negative (it is negative when high values of one variable are observed with low values of the
other). It does not mean that there is a causal relationship between the variables.
Causality: A direction from cause to effect, establishing that a change in one variable
produces a changes in another. While correlation is simply an assessment that two things
have moved together, causation implies a mechanism accounting for the association, and is
therefore a more restrictive concept.
III. GDP and Components
GDP
= aggregate output
A measure of the market value of the output of the economy in a given period.
Gross Domestic Product
o Product = everything that is produced
o Domestic = in the country
o Gross = no discount for depreciation
How to use GDP?
o Level: Measure for the size of the tax base
o Changes over time: Measure for economic growth
o Between countries: Measure for relative economic power
o Per capita: Crude measure for productivity
Economic growth is not a smooth process. We often hear about economies going through a boom or
a recession as growth swings from positive to negative.
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,3 ways to calculate GDP // macro circularity
1. Production approach
Sum of value added of everything produced in the domestic economy
Production is measured by the value added by each industry: this means that the
cost of goods and services used as inputs to production is subtracted from the value
of output. These inputs will be measured in the value added of other industries,
which prevents double-counting when measuring production in the economy as a
whole.
Value added: For a production process this is the value of output minus the value of
all inputs (called intermediate goods). The capital and labour used in production are
not intermediate goods. The value added is equal to profits before taxes plus wages.
2. Income approach
The sum of all incomes received, comprising wages, profits, the incomes of the self-
employed, and taxes received by the government.
3. Spending approach
The total spent by households, firms, the government and residents of other
countries on domestically produced goods and services
The relationship between spending, production, and incomes in the economy as a whole can be
represented as a circular flow: the national accounts measurement of GDP can be taken at the
spending stage, the production stage, or the income stage.
National accounts: The system used for measuring overall output and expenditure in a
country.
Two views on GDP
a. “world’s most powerful statistical indicator of national development and progress” – Philipp
Lepenies (2016)
b. “The welfare of a nation can scarcely be inferred from a measurement of national income as
defined by the GDP.” – Simon Kuznets (1932)
a. Powerful statistical indicator
Integral part of language of macro-economists and statisticians (National accounts, ESA95)
Calculated in all countries at quarterly frequency
b. Bad measure for well-being
Missed traded-offs
o Individual trade-offs: labour leisure
o Societal trade-offs: environment, social cohesion, equality
Not all spending is “happy” spending
o People would rather not spend money on cancer treatment
With consequences
o Society focusses more on production, than on well-being
o Leads to less well-being
GDP components (spending approach)
relates total production (Y) to expenditure (C+I+G+X-M)
Macro-economics National income formula: Y = C + I + G + (X – M)
Y = C + I + G + (X – M)
National income: GDP (Y)
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, To calculate GDP, which is the aggregate demand for what is produced in the country, we
take the total of the components of spending in the economy.
Consumption (C)
Expenditure on consumer goods including both short-lived goods and services and long-lived
goods, which are called consumer durables.
Investment (I)
Expenditure by firms on newly produced capital goods (machinery and equipment) and
buildings, including new housing.
Government Spending (G)
Expenditure by the government to purchase goods and services. When used as a component
of aggregate demand, this does not include spending on transfers such as pensions and
unemployment benefits.
Exports (X)
Domestically produced goods and services that are purchased by households, firms, and
governments in other countries.
Imports (M)
Goods and services purchased by households, firms, and governments in the home economy
that are produced in other countries.
Net exports (X-M)
Also called the trade balance, this is the difference between the values of exports and
imports. The trade balance is a deficit if the value of exports minus the value of imports is
negative; it is called a trade surplus if it is positive.
IV. Okun’s Law
Okun’s law
Relationship between changes in unemployment and changes in output (changes in GDP
growth)
The empirical regularity that changes in the rate of growth of GDP are negatively correlated
with the rate of unemployment. A higher output growth is associated with a decrease in
unemployment and vice versa.
First noted by Arthur Melvin Okun in the 1960s
“Rule of thumb” … no causality
Can be modelled: Y = a + b u
o a, b constants
o Y change in GDP
o u change in unemployment
Note: Core uses u = a +b Y
Okun’s coefficient: The change in the unemployment rate in percentage points predicted to be
associated with a 1% change in the growth rate of GDP.
A fall in output growth A rise in the unemployment rate A fall in wellbeing
V. Fluctuations
Business cycle: Alternating periods of faster and slower (or even negative) growth rates. The
economy goes from boom to recession and back to boom.
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