MACROECONOMICS

(ECON 614, Winter 2020-21)

Introduction to Macroeconomics

Marco Airaudoa
a Drexel University

Drexel University
Jan. 12, 2021

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Microeconomics vs (Modern) Macroeconomics

All economics is based on "microeconomic decisions"

households/consumers maximize utility subject to a budget constraint
…rms maximize pro…ts subject to resources
governments/central banks maximize a "policy objective" (total …scal
revenues, price stability, etc..) subject to macroeconomic constraints
What are the key di¤erences between MICRO and MACRO?
MICROECONOMICS
focuses on individual choices
deals with a limited number of goods
is usually treated in a static context
is often discussed in "partial equilibrium" (prices, aggregate quantities
determined outside the model)

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Microeconomics vs Macroeconomics

MACROECONOMICS
focuses on aggregate variables
considers a large number of goods and activities
is focused on dynamics (how these variables move over time)
is always discussed in "general equilibrium" (studies how aggregate
quantities and prices are determined, in particular as function of
policies)

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Microeconomics vs Macroeconomics

What is the common theme?

Modern Macroeconomics is "micro-founded": it builds on the
aggregation of individual optimizing decisions
=) study how individual decisions (hence, aggregate quantities) vary
as we change the economic environment and/or policies
EX: changing income taxes (or announcing a future change) alters
labor supply decisions of single workers
=) impact on aggregate labor supply and equilibrium wages
=) impact on production, hence income and consumption
Main objectives of macroeconomists
1 Drivers of long-run economic growth and of short-run ‡uctuations
2 Short-run stabilizing properties of monetary-…scal policies

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Key Macroeconomic Indicators: GDP
Income Approach

GDP is the current value, measured in units of domestic currency, of

all …nal goods and services produced within a country in a given
period of time.
It is a measure of production in a given period
It must also be equal to the sum of all incomes generated in a
country within the same period
Ex: a company generates $1 million in revenues to produce bikes. It
pays:
$400K in components (wheels, frames, brakes, etc...), paid to other
suppliers
$200K in wages to workers
$100K in rents
$50K in interest payments on bank loans
$1 million - $750K = $250K in pro…ts for the company owner(s)

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Key Macroeconomic Indicators: GDP
Expenditure Approach

GDP is also computed as the sum of its "expenditure" components:

GDPt = Ct + It + Gt + (Xt IMt )
Private Consumption Ct : all goods (non-durables, durables)/services
purchased by households
Private Investments It : new capital goods purchased by …rms
(machineries, buildings), but also
new residential investments by households (houses)
unsold goods as "inventory investments"
Government Spending Gt : goods/services purchased by the public
sector
it includes also stipends paid to government employees (they give a
service)
it does not include transfers to households (social security, medicaid,
medicare) or interest payments on debt
Net exports Xt IMt (net value could be positive or negative)
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Key Macroeconomic Indicators: GDP
(Log) Nominal GDP

Useful formula:
Yt Yt 1 (1 +g t )
ln(Yt ) ln(Yt 1 ) = ln Yt 1 = ln Yt 1 = ln (1 + gt ) gt
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Key Macroeconomic Indicators: GDP
Caveats

Nominal GDP may grow because

1 indeed the country has produced more, per worker (labor productivity
is higher)
2 goods/services are sold at higher prices
3 labor force is larger

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Real vs Nominal GDP
We have to eliminate the "price growth" e¤ect in nominal GDP
Suppose the economy has N goods. Nominal GDP (superscript nom )
at time t, t + 1, t + 2, ...
Ytnom = p1,t Y1,t + p2,t Y2,t + ... + pN ,t YN ,t
Ytnom
+1 = p1,t +1 Y1,t +1 + p2,t +1 Y2,t +1 + ... + pN ,t +1 YN ,t +1
nom
Yt +2 = p1,t +2 Y1,t +2 + p2,t +2 Y2,t +2 + ... + pN ,t +2 YN ,t +2
We could use always the same prices, across time, by choosing a base
year (say year t): Yt is then real GDP in period t
Yt = p1,t Y1,t + p2,t Y2,t + ... + pN ,t YN ,t
Yt +1 = p1,t Y1,t +1 + p2,t Y2,t +1 + ... + pN ,t YN ,t +1
Yt +2 = p1,t Y1,t +2 + p2,t Y2,t +2 + ... + pN ,t YN ,t +2
Y t +1 Y t
If gt +1 Yt > 0 (positive growth rate for real GDP), it MUST
be because some (maybe all) goods have been produced in larger
quantity
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Key Macroeconomic Indicators: GDP De‡ator

The ratio of nominal GDP Y nom to real GDP Y in a given year t

de…nes an implicit price index:
Ytnom
Pt = 100 = 100 (since t is base year)
Yt
Ytnom
+1 Ytnom
+2
Pt +1 = 100, Pt +2 = 100...
Yt +1 Yt +2

More generally:

Ytnom
+h ∑N
n =1 pn,t +h Yt +h
Pt +h = 100 = 100, for h = 0, 1, 2, ...
Yt +h ∑Nn =1 pn,t Yt +h

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Key Macroeconomic Indicators: GDP De‡ator

Some remarks

1 price index in base year (here t) is normalized to 100.

2 Choice of base year is arbitrary: we could have chosen year t + 1 or
t + 10.
3 However, di¤erent base years may give very di¤erent results for real
GDP growth
Why? Because the relative price of some goods has changed
signi…cantly over time (ex: computers)
To get rid of this bias, economists use the "chain-weighted price
index".

The growth rate of P is what we call the in‡ation rate:

π t = PtPtPt1 1 100

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Key Macroeconomic Indicators: GDP De‡ator
GDP De‡ator (Price Index)

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Key Macroeconomic Indicators: Consumer Price Index
(CPI)
Based on private consumption expenditure on a representative basket
of goods/services (constructed by the BLS) by representative urban
household (survey-based): it measures changes in the average cost of
living.
Let Et be consumption expenditure in year t by representative
household, with xn denoting a speci…c good/service (note: quantities
are …xed!)
Et = p1,t x1 + p2,t x2 + ... + pN ,t xN
Et + 1 = p1,t +1 x1 + p2,t +1 x2 + ... + pN ,t +1 xN
CPI in year t + h is the ratio of Et +h to Eb (b is base year)
Et + h p1,t +h x1 + p2,t +h x2 + ... + pN ,t +h xN
Pt +h = 100 = 100
Eb p1,b x1 + p2,b x2 + ... + pN ,b xN
Pt Pt 1
REMARK: Pb = 100. CPI in‡ation in year t is π t = Pt 1 100.
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Key Macroeconomic Indicators: CPI
Consumer Price Index (CPI)

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GDP De‡ator vs CPI

Both indexes display positive trends, with in‡ation rates spiking up in

the ’70s.
In‡ation signi…cantly lower since early ’80s (the Great Moderation)
CPI-based in‡ation got negative (de‡ation) around 2008, while
remained positive (but close to zero) for the GDP de‡ator
CPI-based in‡ation is, on average, higher and also more volatile
Why these di¤erences?
1 Substitution bias: CPI …xes quantities (representative basket not
revised very often)=)does not account for fact that consumers often
go for cheaper products
2 CPI a¤ected by exchange rates: it includes goods consumed
domestically but produced abroad

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Real GDP: trend vs cycle

NOTE: real GDP is NOT in per capita terms.

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Limitations of real GDP as economic indicator

Not a measure of a nation’s economic well-being

Includes only market activity: no home production, no unrecorded
transactions (underground economy), no illegal goods
Places no value on leisure
Counts both “bads” and “goods”: books vs weapons
Ecological costs are not deducted from GDP
Does not take into account inequalities: GDP is not distributed
equally in society
Does not distinguish between wasteful government expenditure and
productive investments
Does not take into account political freedom and democracy

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Declining Volatilities
Real GDP Growth

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Declining Volatilities
CPI In‡ation

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Declining Volatilities
CPI: Headline vs Core

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References

Garin-Lester-Sims (henceforth, GLS): Ch. 1-3

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