MACROECONOMIE PART 1
Week 1 college 1
HOOFDSTUK 1 – WHAT IS MACROECONOMICS?
Macro-economics = study of the economy as a whole.
> Interaction between markets
Formally, we look at the general equilibrium in the economy.
We will develop a general equilibrium macroeconomic model to understand:
1. The interaction between markets
2. The impact of economic policy decisions
3. The impact of a specific shock (covid-19)
SHORT AND LONG RUN EQUILIBRIUM
Difference between short run changes (cycles) versus long run evolution (trend)
Short run pattern: economic fluctuations are called business cycles.
--> The cycles can be of various lengths and magnitudes.
Macroeconomics tries to explain these deviations from the trend value:
what can be done to smooth these fluctuations?
- Long run: prices are flexible and eventually lead to equilibrium in the
market.
- Short run: prices are fixed and can thus explain yearly fluctuations in real
GDP and unemployment
Unemployment rate = proportion of unemployed workers in the labour force
Ø Labour force = employed + unemployed who want to work
When supply = demand: market is in its long run equilibrium with price = p*
When prices are fixed, but supply is not equal to demand, the adjustment is
made through quantities. In that case, variations in demand determine the
equilibrium output in the short run (IS-TR model)
On the long term however, when prices have adjusted, is the supply capacity
what matters.
It depends on the market (valuta-market, goods-market, …) how fast prices
adjust.
,HOOFDSTUK 2 – MACROECONOMICS ACCOUNTS
GDP
Macroeconomics studies the determinants of the economy’s output and income.
--> Most common measure: Gross Domestic Product (GDP)
GDP = value of final goods and services produced within a given geographic
location during a specific period of time (normally a year).
> Captures the nation’s output and income.
> Varies substantially across countries and time
> Comparable across countries (if divided by population and using same
currency (€)) = GDP per capita
> GDP can give an indication (not a measure!) of economic well-being*
> There is a correlation between GDP and life expectancy
*GDP should NOT be considered to be a perfect indicator for the well-being of a
country, but closest we have that is readily available and comparable.
In the long run, many other indicators of well-being improve with higher GDP.
Crucial for early development of countries:
- Higher GDP à higher living standards, better health, education… à higher
GDP
In the short run: fluctuations of GDP are associated with fluctuations in
unemployment and inflation.
Not captured in GDP: safety, inequality, more human rights, environmental
protection, happiness, …
GDP is a flow variable NOT a stock variable
- Flow variable: quantity measured per unit of time (investments)
Ø Income, budget deficits, …
- Stock variable: quantity measured at a given point in time (capital)
Ø Debt, wealth, …
,DEFINITIONS OF GDP (GDP is always the same for all the 3 definitions!)
1. GDP = the sum of final sales within a geographical location
(country) during a period of time (year)
- Final sales of goods and services sold to consumer or firm that ultimately
uses them (market value)
- Intermediate sales are excluded to avoid double counting
- Used goods are also excluded
2. GDP = the sum of value added within a geographical location
(country) during a period of time (year)
- Value added: difference between sales and the costs of raw material and
intermediate goods
3. GDP = the sum of factor incomes earned from economic activity
within a geographical location (country) during a period of time
(year)
- Factor income: wages (labour), return (capital) and rent (land)
- GDP includes all incomes earned within a country’s borders (residents +
non-residents)
- Because one person’s final spending must be someone else’s income, this
definition of GDP is consistent with first one.
GDP only measures official market transactions.
- No domestic activities or home production (child care, cooking, …)
- Public services (teachers, police, …): not traded, they enter GDP with a
valuation of the cost government (not the selling price)
- Does not include value of shadow or underground economy.
If share of GDP not measured stays stable, then growth rates still good indicator
of the economic activity of an economy.
,NATIONAL ACCOUNTING
Main economic actors:
- Private sector (firms and households)
- The government
- Foreign countries (‘rest of the world’)
DEFINITIONS OF ACCOUNTING
‘letters’:
Y = GDP/output/income
C = consumption
S = savings of private sector
I = investment (good for future use)
T = net taxes = taxes – transfers (pensions,
allowances)
G = government purchases
X = exports
Z = imports
NX = net exports = X - Z
On the consumption side: use 1st definition of GDP
We see that in a closed economy the total final sales of goods & services
produced in the country can be divided into:
Y=C+I+G (total national spending or ‘absorption’)
On the income side: use 3st definition of GDP
We see that in a closed economy the total factor income distributed in a country
can be divided into:
Y=C+T+S
What happens in an open economy, with exports and imports?
- Consumption no longer limited to Y = C + I + G
- Goods & services consumed can also come from abroad: imports Z
(and production can be sold abroad: exports X)
C, I and G can also go to goods produced abroad.
C = Cdomestic + Cforeign I = Idomestic + Iforeign G = Gdomestic + Gforeign
Total imports are: Cforeign + Iforeign + Gforeign
,GDP
For GDP calculation: what has been produced domestically?
Ø Domestic part of C, I and G à subtract Z
To know what the final sales of goods produced in the country are, we have to
deduct imports and add exports:
Y=C+I+G+X–Z
Two decompositions of GDP (give the same Y)
1. Y = C + I + G + (X – Z)
2. Y = C + S + T
--> C + S + T = C + I + G + X – Z
(S – I) + (T – G) = (X – Z)
S – I = private sector (households and firms)
If (S – I) > 0 private sector is a net saver
If (S – I) < 0 private sector is a net borrower
T – G = government
If (T – G) > 0 government is saving
If (T – G) < 0 government is borrowing
X – Z = rest of world
If (X – Z) > 0 the country exports more than it imports
If (X – Z) < 0 the country imports more than it exports
GNI = Gross National Income = define economic activity by its residents, both
people and the firm they own, wherever they produce or earn income.
NDP = Net Domestic Product = GDP – depreciation
Current account + capital account = net national saving = X - Z
à Positive = lending & negative = borrowing
Financial account = what is being lent or borrowed
> Positive = lending, so money flows out to purchase foreign assets
> Negative = borrowing, so money flows in because of selling assets to
foreigners
Errors and omissions = FA – CA + ΔR (foreign exchange reserves)
, INFLATION
Quantities produced is not the same as the value of the production.
Nominal GDP is computed using the actual selling price in year t (current):
Nominal GDPt = patQat + pbtQbt
Real GDPt is computed using the price of a given base year 0 (constant):
Real GDPt = pa0Qat + pb0Qbt
Ø Prices are kept fixed so that real GDP varies only if the physical quantity
sold, or quantity produced, changes
When we see an increase in nominal GDP, how much of this increase is due to
prices? How much is due to quantities?
- Need to measure how quantities and prices change over time
- Change of prices over time is simply the inflation rate
The GDP deflator
One important measure of price level changes is the GDP deflator
GDP deflator = Pt = (nominal GDPt) / (real GDPt)
- Measures the price of output relative to its price in the base year
- In base year t = 0 and p0 = 1, in other years measures deviation from t0
> If in year t, Pt = 2, means prices have doubled relative to base year.
If we use difference in the changes (Δ) of real and nominal GDP then is the GDP
deflator a good measure of inflation (measured by ΔP)
Δ Nominal GDP – Δ Real GDP = (approximately) ΔP
EXAMPLE
GDP deflator of the Netherlands between 2010-2011
Nominal GDP 2010 = €625b 2011 = €703b
Real GDP 2010 = €625b 2011 = €685b
(703 – 625)/625 – (685 - 625)/625 = 0,1248 – 0,096 = 0,028
Inflation = (approximately) 2,8% (exact value: (P2011 - P2010)/ P2010 = 2,6%
Increase in nominal GDP (12,48%) can be explained (decomposed) by a change
in quantity (Δ real GDP = +9,6%) & change in prices (ΔP = +2,8%)
When there are more than 2 goods and more prices:
- Construct the GDP deflator
- Compute a weighted average of unequal prices
- Weights are given by the proportion of each good in the GDP
