ALL THE NOTES YOU WILL NEED TO PASS THE EXAM. Second-year second-semester macroeconomics notes, all chapters start to finish. Notes made from the lecture slides, textbook and lecturer talking points thus making them in-depth and comprehensive.
ECO2004S
W1 Chapters 1: Introduction & A Tour of the World
Macroeconomics is the study of the economy as a whole. It deals with broad aggregates. Its goal is
to explain the economic changes that a ect many households, rms, and markets at once.
Macroeconomic Problems
➢High in ation rate
➢ High unemployment rate
➢ High interest rates
➢ Low economic growth or stagnation
➢ High public debt
The Global Financial Crisis
- From 2000 to 2007, the world economy had a sustained expansion.
- In 2007, U.S. housing prices started declining, leading to the sub-prime mortgage crisis and to a
major nancial crisis.
- The nancial crisis turned into a major economic crisis with falling stock prices.
- In the third quarter of 2008, U.S. output growth turned negative and remained so in 2009.
- Through the trade and nancial channels, the U.S. crisis quickly became a world crisis
Sub-prime: Subprime refers to borrowers or loans, usually o ered at rates well above the prime rate,
that have poor credit ratings. Subprime lending is higher risk, given the lower credit rating of
borrowers, and has in the past contributed to nancial crises
The Euro Area:
The European Union (EU) is currently a group of 27 European countries with a common market.
- The United Kingdom withdrew from the European Union on January 31, 2020.
- In 1999, the EU formed a common currency area called the Euro area, which replaced national
currencies in 2002 with the euro.
Much of the high unemployment rate was the result of the crisis.
- Supporters of the euro argue: economic advantages due to no more changes in exchange rates to
worry about its contribution to the creation of a large economic power
- Others argue: the drawback of a common monetary policy across euro countries the loss of the
exchange rate as an adjustment instrument within the euro area
The United States
Q: Why did the Federal Funds rate stop at zero?
A: This constraint is known as the zero lower bound. If it were negative, then everyone would hold
cash rather than bonds.
Q: Why are low interest rates a potential issue?
A: Low interest rates limit the Fed’s ability to respond to further negative shocks. Low interest rates
may lead to excessive risk taking by investors to increase their returns.
The slowdown in productivity growth is worrisome because the standard of living especially for the
poor may not increase.
China
- China has been growing very rapidly for more than three decades
- China’s rapid output growth is driven by high accumulation of capital and technological progress.
- The slowdown after the crisis is considered to be desirable as more of output would go to
consumption instead of investment.
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Chapter 2: Key Macroeconomic Variables
—> In short run demand determines output
• Intermediate good - is a good used in the production of another good. Some goods can be a
intermediate AND nal good (i.e. potatoes it just depends on the intent when selling)
• Price Index - A measure of the price level.
• Consumer Price Index (CPI) - is a measure of the overall cost of the goods and services bought
by a typical consumer
- It is used to monitor changes in the cost of living over time.
- When the CPI rises, the typical family has to spend more rands to maintain the same standard of
living.
The CPI is calculated as follows:
(1) de ne a market basket,
(2) determine how much it would cost to purchase the market basket in the current year and in the
base year
(3) divide the Rand cost of purchasing the market basket in the current year by the Rand cost of
purchasing the market basket in the base year, and
(4) multiply the result by 100.
Example:
Base Year is 2002, CPI in 2002 is 100
- Basket of goods in 2002 costs R1,200
- The same basket in 2004 costs R1,236
- CPI = (R1,236/R1,200) x 100 = 103
Prices increased 3 percent between 2002 and 2004
• In ation - refers to a situation in which the economy’s overall price level is rising.
- The in ation rate is the percentage change in the price level from the previous period
- In ation measures the Cost of Living
- CPI & GDP de ator are the proxies for in ation.
The In ation Rate is calculated as follows:
Problems in Measuring the Cost of Living
• The CPI is NOT a perfect measure of the cost of living.
• The substitution bias or the introduction of new goods may cause the CPI to overstate the true
cost of living.
The GDP De ator versus the Consumer Price Index
• The GDP de ator re ects the prices of all goods and services produced domestically,
• Whereas the consumer price index re ects the prices of all goods and services bought by
consumers (these goods CAN include imported goods).
• Producer price index measures the cost of a basket of goods and services bought by rms rather
than consumers.
GDP and GNP
Gross domestic product (GDP) measures the output produced by factors of production located in
the domestic economy
Gross national product (GNP) measures the output produced by domestic citizens (domestically or
abroad)
- GNP = GDP + net income from abroad
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Income measures
Nominal GDP is the sum of the quantities of nal goods produced times their current price.
Nominal GDP increases for two reasons:
- The production of most goods increases over time
- The price of most goods increases over time
Our goal is to measure production and its change over time.
Nominal GDP is also called GDP in current prices.
Real GDP is the sum of quantities of nal goods times constant (not current) prices.
- Real GDP is an important number that gives the economic size of a country i.e. a country with
twice the GDP of another country is economically twice as big as the other country.
- Equally important is the level of GDP per person , the ratio of real GDP to the population of the
county gives the average standard of living of the country.
Real GDP is also called GDP in terms of goods, GDP in constant prices, GDP adjusted for in ation
There are two main ways in which in ation impacts the measurement of GDP:
Nominal GDP vs. Real GDP:
• Nominal GDP is calculated using the current market prices of goods and services. It does not
account for changes in the price level over time, including in ation.
• Real GDP is calculated using constant prices from a base year, e ectively removing the impact
of price changes. Thus Real GDP is adjusted for in ation, which means it re ects the changes in
the quantity of goods and services produced.
From now on GDP will refer to Real GDP & Yt will denoted real GDP in year t
Nominal GDP & variables measured in current prices will be denoted with a dollar sign infant of them
**i.e. ($Yt ) is equal to the GDP de ator (Pt) times real GDP (Yt ).
- $Yt = PtYt
Economic Growth
measured by increases in Real GDP:
What’s NOT Included in GDP
- Certain non-market goods and services sold/performed at home by family members.
- Sales of used (secondhand) goods
- Financial transactions such as trading of stocks and bonds
- Government transfer payments such as social security
- Value of leisure time & clean environment
- Underground activities (illegal activities)
GDP is the best single measure of the economic well-being of a society.
- GDP per person tells us the income and expenditure of the average person in the economy.
- Higher GDP per person usually indicates a higher standard of living
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- BUT what about income distribution?
- GDP is not a perfect measure of the happiness or quality of life.
+’ve GDP growth = expansions
-‘ve GDP growth = recessions
Ways to Compute GDP
- Production Approach: Output - intermediate consumption + taxes on products – subsidies on
products
*Goods that are inputs for the production of nal goods.
‣ Household Sector - Consumption
‣ Business Sector - Investment
‣ Government Sector – Government Purchases
‣ Foreign Sector – Net Exports
**GDP = C + I + G + (X – M)
• major drawback of this method is the di culty to di erentiate between intermediate and nal
goods.
- Income Approach: add the sum of all incomes earned (wages, interest, rents, and pro ts) in
producing goods and services
- Value-added Approach: add the value added at each stage of production of all goods and
services
SUMMARY:
**Hedonic price method uses the value of a surrogate good or service to measure the implicit price
of a non-market good. For example, house prices can be used to provide a value of particular
environmental attributes.
The Unemployment Rate
Employment is the number of people who have a job.
Unemployment is the number of people who do not have a job BUT are looking for one.
The labor force is the sum of employment and unemployment.
Discour aged workers are those persons who give up looking for a job and so no longer count as
unemployed.
The participation rate is the ratio of the labor force to the total population of working age.
Because of discouraged workers, a higher unemployment rate is typically associated with a lower
participation rate.
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