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Summary Introduction to Macroeconomics: Business Economics BA1- VUB
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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Business Economics- Bachelor 1: Macroeconomics summaryIntroduction 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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