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Macroeconomics
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Macroeconomics1. Introduction to Macroeconomics
Economics is a social science that studies the allocation of scarce resources for alternative
purposes.
Macroeconomics analyzes the aggregate quantities and prices in the entire economy and
other aggregate variables.
Schools of Economic Thought
● Classical School (1930s) – Markets tend to function well, and government
intervention should be reduced as much as possible for the better functioning of the
economy.
● Keynesian School (1940s-1970s) – Markets may fail in important ways and
government intervention often improves the functioning of the economy by
stimulating Aggregate Demand.
● Neoclassical School (1980s-mid-1990s)
● Synthesis (mid-1990s-present)
Macroeconomics as a Science
● Uses the scientific method
○ Builds models/theories to explain reality (reach conclusions, make
predictions, etc.)
○ Conclusions and predictions can be tested
○ If the model fails to explain the data, new theories are created
The National Accounts
GNP (Gross National Product) is the market value of the production of final goods and
services carried out in an economy, in one year, by domestically owned productive
factors.
● Real GNP is the value of the production of final goods and services carried out in one
year, by domestically owned productive factors, using the prices of a base year
(adjusted for inflation).
● Nominal GNP increases over time because…
○ The production of most goods increases over time
○ The prices of most goods increase over time
■ Inflation affects Nominal GNP.
● In the base year, Nominal GNP = Real GNP.
● Changes:
○ Changes in Nominal GDP can be due to changes in prices or changes in
quantities of output produced.
○ Changes in Real GDP can only be due to changes in quantities of output
produced because Real GDP is constructed using constant base-year prices.
,GDP (Gross Domestic Product) is the market value of production of final goods and services
carried out in an economy, in one year, by the productive factors located in the country.
● Limitations of GDP – GDP is not a perfect measure of the overall standard of living or
well-being of a country.
○ The exclusion of non-market transactions (e.g. household work, black market)
○ The failure to account for or represent the degree of income inequality in
society (as opposed to the Gini Index)
○ The failure to indicate whether the nation's rate of growth is sustainable or not
○ The failure to account for externalities (e.g. social costs)
● Measuring GDP in terms of GNP
○ GDP = GNP + income of foreign factors located in the country – income of
national factors located abroad
● Ways to measure GDP
1. Aggregate Expenditure (Expenditure Approach) – adds up the value of
purchases made by final users
● Aggregate supply and demand:
○ In the short term, GDP depends on the evolution of the components of
demand.
○ In the long term, GDP depends on the evolution of supply conditions
(technological innovations, the productivity of labor and capital…)
2. Value Added Approach (Production Approach) – measures the contribution of
capital and labor to production
● Sums the "value-added" at each stage of production, where value-
added is defined as total sales less the value of intermediate inputs
into the production process
● Formula:
○ VA = Value of Sales – Cost of Embedded Intermediate Goods
○ GDP = Sum of the added value of all sectors of the economy
3. Income Approach – sums the incomes generated by production
, ● By definition, the total production of final goods and services is equivalent to the sum
of value added, the sum of earned incomes, and total expenditures.
● GDP (income) per Capita = Real GDP ÷ population
Economic growth is the rate of increase in real GDP (i.e. increased production of goods and
services).
● Economic cycles:
○ Expansion – positive growth periods (GDP increasing)
○ Recession – negative growth periods (GDP declining)
National Income (NI)
● NI = GNP - depreciation of capital (K) - indirect taxes + subsidies
Origin of income:
● From Labor: salary, wages, payments in kind…
● From Capital: profits, dividends, interest…
● From Land: rental income, capital gains…
Inflation
Inflation is the aggregate increase in the level of prices in the economy.
● How to measure inflation:
1. The percentage increase in the Consumer Price Index (CPI): the weighted
average price of a list of more than three hundred goods and services,
, calculated relative to a base year
Inflation Rate = (CPI given year – CPI base year / CPI base year) x 100
2. GDP Deflator
→ – 100
Nominal GDP = p (given year) x q (given year)
Real GDP = p (base year) x q (given year)
Inflation Rate =
(GDP Deflator given year – GDP Deflator base year / GDP Deflator base
year) x 100
● The rate of inflation is the percentage change in the overall level of prices.
○ It varies greatly over time and across economies.
○ It affects the purchasing power of economic agents (e.g. customers, firms,
and governments).
● The inflation target for developed economies is set at around 2% by CB to guarantee
price stability.
● Types of inflation
○ Demand-driven Inflation – caused by an expansion of aggregate demand
○ Supply-driven Inflation – caused by a contraction of the aggregate production
○ Core Inflation – Inflation rate eliminating the price of imported raw materials,
fuel, and unprocessed food
● Costs of inflation
○ It reduces the purchasing power of wages (not homogeneous or “fair”).
○ It makes economic planning difficult for families and companies.
○ Prices may lose informative value, so the market economy is less efficient.
○ It mainly hurts money holders and favors debtors (if unexpected).
○ It creates uncertainty.
○ It harms economic activity.
Hyperinflation is a very high inflation rate (above 10%).
Deflation is a negative inflation rate.
● Deflation generates a negative spiral: Deflation → Recession → Deflation
● It should be avoided at all costs.
Unemployment
● Labor force – People who, by age and health, can work and are looking for a job.
○ Employed – have a job
○ Unemployed – do not have a job; looking for one
● Population not in the labor force does not count toward the unemployment rate.
○ Only those looking for work are counted as unemployed.
○ Those not working or looking for work are not in the labor force.
○ People without jobs who give up looking for work are known as discouraged
workers.
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