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Summary Introduction to Macroeconomics: Business Economics BA1- VUB
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  • Course
  • Introduction To Macroeconomics
  • Institution
  • Vrije Universiteit Brussel (VUB)
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  • Economics

This is a summary of the Introduction to Macroeconomics course in the first bachelor Business Economics at the VUB. I got 14/20 with this summary.

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  • 2de helft van het boek (1ste helft behandelt in microeconomics)
  • September 15, 2022
  • 42
  • 2022/2023
  • Summary

Subjects

  • inflation
  • banks
  • money market
  • customers

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Business Economics- Bachelor 1: Macroeconomics summary
Introduction to macroeconomics: measuring a Nation’s wellbeing
1. Microeconomics vs Macroeconomics
 Microeconomics: individual agents, How people make decisions, how they interact. Studies the way in which
households/firms make decisions, how they interact in markets.
 Macroeconomics:
 How economy as a whole works, economic reality (inflation, economic growth, unemployment).
 Lumps All the households together in one group and looks at them as an aggregate -> what is the
income of all firm in one sector combined?
 Prices as a whole and see if they go up or down (their fluctuations)
 Lump together all the labour markets (unemployment on aggregate level), financial markets (interest
rate as a result of supply and demand, exchange rates). All of those variables have an impact on decision
of individual agents.

2. Structure
1) Measuring economy as a whole: product & income, overall level of prices.
2) Analysis economy in long run (trendline): Economy growing faster then trendline: costs (unemployment, loss
output), Economy growing slower then trendline: Inflation goes up, prices goes up.
 Production & Growth
 Unemployment
 Financial system: money & prices (central bank)
 Model of open economy (trade with rest of the world)
3) Analysis economy in the short run: macroeconomic policy -> monetary policy, fiscal policy.

3. Measuring a nation’s wellbeing: circular flow
 Equality of income and expenditure. All the transactions between
households and firms.
 Circular flow diagram is a flowchart of the economy that shows the input
and output of households and firms.
 Real flows -> goods, services and factors of production, households own
the factors of production
 Payment flows -> flow that represents the financial payments.
 Each flow is equally large, closed and equal in output value.
 Production ≡ (identical to) income ≡ expenditures.

4. Gross domestic product (GDP)
 Measures all the output produced in the economy. GDP measures the wellbeing of the economy: total income,
total expenditures.
 GDP (Gross domestic product): the Market value of all the final goods and services that are produced within a
country in a given period of time.
 The market value: use the market value and price of each output at its market price and add up the
outputs. What with goods/services that aren’t sold in a market? And informal markets -> not included in
GDP.
 Of all: GDP includes all items produced in the economy and sold in markets. GDP measures the market
value.
 Final: we don’t count intermediate goods only final goods to avoid double counting. Only measures the
end of the chain.
 Goods and services: equally valuable in the count of GDP
 Produced: Produced in a country in a period of time. Products from a different period of time are not
included in the current GDP, doesn’t include second-hands goods traded. The service provided in the
selling of a used good , is included in the current GDP.
 Country: geographical criteria to identify where the good is done and where the service happened. z
 In a given period: time frame to compute GDP, “flow variable”, quantity per unit of time, per quarter,
per year. Stock variable: quantity at a certain amount of time.
 GDP is used to measure the market value of all financial goods and services produced within a country in a given
amount of time.

, Limitations of GDP: Well-being is subjective (different for everybody), higher income does not always mean higher
well-being, illegal activities do not add to GDP.
 3 ways to compute GDP: production, Income, Expenditures approach.
 Production Approach: problem of double counting
n
a) Find ∑p I, t qi,t (final goods and services) = GDP -> only use final goods and services
i=1
b) Value added = Market value of production – Cost of non-factor inputs. (Example in notes)
 Income approach: GDP is the sum of all value added. The total added value = income. GDP estimates from the
income approach tends to be lower than the GDP from the value added approach. GDP = Wages + rents + profits
= income
 Expenditures approach: households consumption ( C ) = spending on goods and services.
+ investment -> spending on equipment, physical capital (machines, tools), structures (inc. new housing), changes
in inventories -> e.g. -> car produced in 2020 but not sold -> should be included in 2020 GDP isn’t included in 2020
C, Change in inventory in 2020: + 20 000. In 2021: C= +20 000, change in inventory: - 20 000.
+ Government purchases of goods and services G -> spending on goods and services by the government also
included: spending on infrastructure, estimate market value of government services ≈ wages of government
employees. Does not include: transfer payments (unemployment benefits, state pension, subsidies).
+ Net Exports: exports – Imports.
 GDP = C + I + G + NX (exports – Imports)




5. Nominal vs Real GDP
 Nominal GDP: uses current prices to value the economy’s production of goods and services.
n
 Nominal GDPt = ∑p I,t qi,t ( GDP at correct prices). Change in GDP can be caused by either q i (“real
i=1
changes”) or pI ( nominal changes). To look only at the effect of qi , we use real GDP.
 Real GDP: uses constant base year prices to value the economy’s production of goods and services.
n
 Real GDPt = ∑p I,b qi,t = GDP at constant prices, PI,b = price of base year. Real GDP changes only because
i=1
q change (example in notes)
 Real GDP is a better measure of wellbeing because it measures the evolution of value and price.

6. GDP deflator how many How many
 How many times nominal GDP is higher than in the base year times real GDP x times price is
is higher than higher than in
in base year the base year

 The GDP deflator measures the level of prices in an economy.
 Suppose prices x 3 and q x 2 -> nom GDP with factor 6.
 Nom GDPt = real GDPt x Pt -> We know that nom GDPb = real GDPb, multiply both sides by real GDPb, solve for
Pt <=>
Nom GDPb real GDPb
 Pt = nom GDPt = GDP deflator. (Example in notes)
Real GDPt
a) Measures by which factor prices have increased compared to the base year.
b) Have no units (index)
c) Is 1 in base year.
d) Is usually expressed wit ,h base = 100 -> Pb x 100 = 100.
 Why Pt is this called the GDP deflator: => real GDPt = (example in notes)


7. GDP and economic wellbeing
 In a graph: X:axis -> GDP per person. Y:axis -> things other than GDP.
 GDP is a useful measure of wellbeing but also an imperfect measure of economic wellbeing.
 GDP does not take into account: Leisure, Non-market activities, The environment, pollution, poverty, income
distribution.

,8. The limitations of GDP as a measure of well-being
 Critics -> GDP is too focused on material possessions and income. Many things are not measured by GDP but
contribute to the quality of life and economic wellbeing ( health of country’s children, quality education).
 Nations with larger GDPs can afford better healthcare, education systems.
 Some things that contribute to a good life are left out of GDP
 Leisure: if people work every day rather than enjoy leisure in the weekend -> more goods produced,
GDP rises -> but wellbeing has not improved.
 Work in home and volunteer work: Because GDP uses market prices to value goods and services, it
excludes value of activity that takes place outside the markets. Volunteer work improves wellbeing but
GDP doesn’t reflect this.
 Quality of environment: if government eliminates all environmental regulations -> firms could produce
without considering the pollution -> GDP rises but wellbeing falls.

, Macroeconomics: Measuring the cost of living
1. Consumer price index (CPI)
 GDP deflator may not be the best to measure the cost of living.
 Consumer price index: measure of the overall goods and services that are bought by a typical consumer.
 Basket= goods and services bought by a consumer (for a year)
1) Survey consumers to determine a fixed basket of goods -> households have to take track of all the goods they buy
during a year. Statisticians compute on average what is bought, what prices are most important to the typical
consumer. E.g. -> 4 salads, 2 burgers/ year.
2) Find the price of each good in each period: e.g. 2019: €1/ salad , €2/burger
2020: €2/salad, €3/burger
3) Statistician compute the price of the basket of goods in each period:
e.g. 2019: ( €1/salad x 4 salads) + (€2/burger x 2 burgers) = €8
2020: (€2/salad x 4 salads) + (€3/burger x 2 burgers) = €14

4) Choose a base year (b = 2019) and compute the index:
CPIt = Price of basket in period t x 100
Price of basket in base period
e.g. CPI2019 = (€8/€8) x 100 = 100 -> index b = 100 (index base year always 100)
CPI2020 = (€14/€8) x 100 = 175 -> index has no units.

5) Use the CPI to compute the inflation rate
π t = CPIt – CPIt-1 x 100% => π 2020 = 175 – 100 x 100% = 75%
CPIt-1 100

2. Problems with CPI
 Goal of CPI is to measure changes in the cost of living, how much people must pay to purchase goods and
services.
 Reasonably good measure of levels of prices but often it creates a number of problems.
 Ignores changes in prices and affects changes in quantity demanded => e.g. when you have an income of
120/week and only buys burgers for €2/burger -> you buy 60 burgers a week. In 2020, the price of burgers rises to
€3, now you can only buy 40 burgers -> standard of living has fallen. To keep their standard of living constant,
income must rise.
 If income rises by a lower percentage than the CPI -> standards of living eroded. If income rises at a faster rate
than CPI -> standards of living improved.
1. Substitution bias -> consumers change their purchasing behaviour as the price changes. they ignore the
fact that q changes when P changes. But in the CPI: q salads, q burgers are fixed. So the weight of P
salad in index is too large.
P salad q salads
P burger (substitution) q burgers
2. New Goods -> Not taken into account when computing the CPI, happens with a delay. Every year the
basket of goods is revised but that means that the CPI is running a little bit behind.
3. Unmeasured quality change -> price increase reflects increase in quality -> when the quality of a good
changes, when a car has more horse power, better fuel mileage -> they adjust price of the good to
account for the quality change. CPI doesn’t capture quality change that is not reflected in the
description of the goods. E.g. -> cars of today have a better quality then cars of 20 years ago.
4. Weights qi not representative to all consumers -> the basket of goods that is representative of the
households on average may not be representative of you as a consumer. E.g. Diapers (only people with
a baby use diapers, but it can still be in the basket of goods).
 Despite these problems just like the GDP, the CPI is a useful measure of the price level of the cost of level.
 ECB has an inflation target at 2%.

3. Difference between GDP deflator and CPI

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