Macroeconomics

Lecturer: Yang Li ， Professor ， School of

Economics ， SCU
Contact info: liyangecon@scu.edu.cn

Reading list for Lecture 1:

Mankiw Chapter 1,2
Abel, Bernanke & Croushore Chapter 1 ，
2
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 1. What Macroeconomics is about
Lecture 1: Introduction 2. Course Syllable
3. The Data of Macroeconomics

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1. What Macroeconomics Is Abo
ut
• Macroeconomics: the study of structure and performance of
national economies and government policies that affect econ
omic performance
• Issues addressed by macroeconomists:
– Long-run economic growth
– Business cycles
– Unemployment
– Inflation
– The international economy
– Macroeconomic policy
• Aggregation: from microeconomics to macroeconomics
Long-run Economic Growth
Figure 1.1: Output of the U.S. economy, 1869–2014
* Note decline in output in recessions; increase in output in some wars

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Two main sources of growth
• Population growth
• Increases in average labor productivity

Average labor productivity

• Output produced per unit of labor input
Figure 1.2: Average labor productivity
in the United States, 1900–2014
Business cycles
– Business cycle: Short-run contractions and expansions
in economic activity
– Downward phase is called a recession

Unemployment
– Unemployment: the number of people who are availabl
e for work and actively seeking work but cannot find jo
bs
– U.S. experience shown in Fig. 1.3
– Recessions cause unemployment rate to rise
Figure 1.3: The U.S. unemployment rate, 1890–2014
Inflation
Figure 1.4: Consumer prices in the United States, 1800–2014
The international economy
– Open vs. closed economies
• Open economy: an economy that has extensive trad
ing and financial relationships with other national ec
onomies
• Closed economy: an economy that does not interact
economically with the rest of the world
– Trade imbalances
• U.S. experience shown in Fig. 1.5
• Trade surplus: exports exceed imports
• Trade deficit: imports exceed exports
Figure 1.5: U.S. exports and imports, 1869–2014
Macroeconomic Policy
– Fiscal policy: government spending and taxatio
n
• Effects of changes in federal budget
• U.S. experience in Fig. 1.6
• Relation to trade deficit?
– Monetary policy: growth of money supply; dete
rmined by central bank; the Fed in United State
s
Figure 1.6: U.S. Federal government spending and t
ax collections, 1869–2014
GDP （ nominal ） Per Capita 2015
(IMF)

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 Aggregation
Macroeconomics & Microeconomics
• Microeconomics is the study of how households and firms make d
ecisions and how these decision makers interact in the broader mar
ketplace. In microeconomics, an individual chooses to maximize his
or her utility subject to his or her budget constraint
• Macroeconomic events arise from the interaction of many individual
s trying to maximize their own welfare. Because aggregate variables
are the sum of the variables describing individuals’ decisions, the st
udy of Macroeconomics is based on microeconomic foundations.

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Models, Endogenous & Exogenous Var
iables

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Example: The Model of Supply and Demand

What are the

endogenous variables?

P, Q

What are the

exogenous variables?

Production cost,
Price of other goods,
Income level etc.

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 Why Macroeconomists Disagre
e
• Positive vs. normative analysis
– Positive analysis: examines the economic cons
equences of a policy
– Normative analysis: determines whether a poli
cy should be used
• Classicals vs. Keynesians
– The classical approach
• The economy works well on its own
• The “invisible hand”: the idea that if there ar
e free markets and individuals conduct their
economic affairs in their own best interests,
the overall economy will work well
• Wages and prices adjust rapidly to get to e
quilibrium
– Equilibrium: a situation in which the quantities d
emanded and supplied are equal
– Changes in wages and prices are signals that c
oordinate people’s actions
• Result: Government should have only a limi
ted role in the economy
• Classicals vs. Keynesians
– The Keynesian approach
• The Great Depression: Classical theory faile
d because high unemployment was persiste
nt
• Keynes: Persistent unemployment occurs be
cause wages and prices adjust slowly, so m
arkets remain out of equilibrium for long peri
ods
• Conclusion: Government should intervene to
restore full employment
• Classicals vs. Keynesians
– The evolution of the classical–Keynesian
debate
• Keynesians dominated from WWII to 1970
• Stagflation led to a classical comeback in th
e 1970s
• Last 30 years: excellent research with both a
pproaches
• A unified approach to macroeconomics
– We use a single model to present both classical a
nd Keynesian ideas
– Three markets: goods, assets, labor
– Model starts with micro-foundations: individual be
havior
– Long run: wages and prices are perfectly flexible
– Short run: Classical case—flexible wages and pri
ces; Keynesian case—wages and prices are
slow to adjust
 1. What Macroeconomics is about
Lecture 1: Introduction 2. Course Syllable
3. The Data of Macroeconomics

Course Outline
Lecture 1: Introduction
Classical Theory: The Economy in the Long Run
Lecture 2: National Income
Lecture 3: Money and Inflation
Lecture 4: The Open Economy
Lecture 5: Unemployment and the Labor Market
Growth Theory: The Economy in the Very Long Run
Lecture 6: Economic Growth
Business Cycle Theory: The Economy in the Short Run
Lecture 7: Economic Fluctuations
Lecture 8: Aggregate Demand
Lecture 9: The Mundell – Fleming Model and the Exchange – Rate Regime
Lecture 10: Aggregate Supply and the Short-Run Tradeoff Between Inflation and Unem
ployment
Lecture 11: A Dynamic Model of Aggregate Demand and Aggregate Supply
Macroeconomic Policy Debates
Lecture 12: Stabilization Policy
Lecture 13: Government Debt and Budget Deficits
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Textbook: Mankiw Macroeconomics 10E

N. Gregory Mankiw is the Robert

M. Beren Professor of Economics
at Harvard University.

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Abel, Bernanke & Croushore Macroeconomics 10E

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 Course Assessment

• 4 Homework assignments, 15% each

• Class participation, 20%

• Presentation, 20%

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 1. What Macroeconomics is about
Lecture 1: Introduction 2. Course Syllable
3. The Data of Macroeconomics

3.1 Gross Domestic Product

• Gross Domestic Product (GDP) is the market value of all final
goods and services produced within an economy in a given period
of time.
• It is often considered the best measure of how well the economy is
performing.
• It is often computed from a large number of primary data sources.
The primary sources include both administrative data, which are
byproducts of government functions such as tax collection,
education programs, defense, and regulation, and statistical data,
which come from government surveys of, for example, retail
establishments, manufacturing firms, and farm activity.

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3.1.1 Income, Expenditure, and the Circular Flow
Income ($)
There are two ways of comput
Labor
ing GDP:
1. Total income of everyon
e in the economy
2. Total expenditure on th
Households
Circular Firms
e economy’s output of g Flow
oods and services
For the economy as a whole, i
ncome must equal exp Goods and Services

enditure. Expenditure ($)

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 Stocks and Flows

• Stock is a quantity measur

ed at a given point in time
• Flow is a quantity measure
d per unit of time
• A person’s wealth is a stoc
k, his income and expendit
ure are flows
• GDP measures the _____
of dollars in the economy?

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 3.1.2 Rules for computing GDP

• To compute the total value of different goods and services, the natio
nal income accounts use market prices. Thus if we have:

4× $0.50 3× $1.00

GDP = (Price of apples  Quantity of apples)

+ (Price of oranges  Quantity of oranges)
= ($0.50  4) + ($1.00  3)
GDP = $5.00

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• Used goods are not included in the calculation of GDP.
• The treatment of inventories depends on if the goods are stored or if they s
poil. If the goods are stored, their value is included in GDP. If they spoil, GD
P remains unchanged. When the goods are finally sold out of inventory, they
are considered used goods.
• Intermediate goods are not counted in GDP– only the value of final good
s. Reason: the value of intermediate goods is already included in the marke
t price. Value added of a firm equals the value of the firm’s output less the v
alue of the intermediate goods the firm purchases. For the economy as a wh
ole, the sum of all value added must equal the value of all final goods and s
ervices. Hence, GDP is also the total value added of all firms in the econom
y.

+ =
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• Some goods are not sold in the marketplace and therefore don’t hav
e market prices. We must use an estimate of their value. Such an es
timate is called an imputed value.
• For example, A person who rents a house is buying housing service
s and providing income for the landlord; the rent is part of GDP, both
as expenditure by the renter and as income for the landlord.
• Many people, however, own their homes. Although they do not pay r
ent to a landlord, they are also enjoying housing services.
• To take account of the housing services enjoyed by homeowners, o
ne way is to estimate what the market rent for a house would be if it
were rented and includes that imputed rent as part of GDP.
• This imputed rent is included both in the homeowner’s expenditure a
nd in the homeowner’s income.
• Other example: government services

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• No imputation is made for the value of goods and services sold in
the underground economy.
• The underground economy is the part of the economy that people
hide from the government either because they wish to evade
taxation or because the activity is illegal.
• Examples include domestic workers paid “off the books” and the
illegal drug trade.
• In the United States, the underground economy is estimated to be
less than 10% of the official economy, whereas in some developing
nations, such as Thailand, Nigeria, and Bolivia, the underground
economy is more than half as large as the official one.
• Because the imputations are only approximate, and the value of
many goods and services is left out altogether, GDP is an imperfect
measure of economic activity. These imperfections are most
problematic when comparing standards of living across countries.
• Yet as long as the magnitude of these imperfections remains fairly
constant over time, GDP is useful for comparing economic activity
from year to year.
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 3.1.3 Real GDP Versus Nominal GDP
• The value of final goods and services measured at current prices is call
ed nominal GDP. It can change over time, either because there is a cha
nge in the amount (real value) of goods and services or a change in the
prices of those goods and services.
• Real GDP is the value of goods and services measured using a consta
nt set of prices, which is the market prices of some base year.
• GDP of China in 2020(nominal) 101.6 trillion RMB
• (Real) GDP growth 2.3%

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 Let’s see how real GDP is computed in our apple and
orange economy.
For example, if we wanted to compare output in 2009, 2010 and 2011,
we would obtain base-year prices, such as 2009 prices.

Real GDP in 2009 would be:

(2009 Price of Apples  2009 Quantity of Apples) +
(2009 Price of Oranges  2009 Quantity of Oranges).
Real GDP in 2010 would be:
(2009 Price of Apples  2010 Quantity of Apples) +
(2009 Price of Oranges  2010 Quantity of Oranges).
Real GDP in 2011 would be:
(2009 Price of Apples  2011 Quantity of Apples) +
(2009 Price of Oranges  2011 Quantity of Oranges).

Note that 2009 prices are used to compute real GDP for all three years.
Because prices are held constant from year to year, real GDP varies
only when the quantities produced vary.

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 3.1.4 The GDP Deflator

The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year.
It reflects what’s happening to the overall level of prices in the
economy.

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 3.1.5 Chain-Weighted Measures of Real GDP

• In some cases, it is misleading to use base-year prices that prevailed 10 or 20

years ago (i.e., computers and university tuition fees).
• In 1995, the Bureau of Economic Analysis of the US decided to use chain-wei
ghted measures of real GDP. The base year changes continuously over time.
This new chain-weighted measure is better than the more traditional measure
because it ensures that prices will not be too out of date.
• Average prices in 2009 and 2010 are used to measure real growth from 2009
to 2010. Average prices in 2010 and 2011 are used to measure real growth fro
m 2010 to 2011, and so on. These growth rates are united to form a “chain” th
at is used to compare output between any two dates.
• In China, the base year will be changed every 5 years, the current base year i
s year 2015.
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 3.1.6 The Components of Expenditure

YY =
= CC +
+ II +
+GG+
+ NX
NX
Totaldemand
Total demand Investment
Investment
fordomestic
for domestic spendingby
spending by
output(GDP)
output (GDP) businessesand
businesses and
households
households Netexports
Net exports
ornet
or netforeign
foreign
Consumption
Consumption Government demand
demand
Government
spendingby
spending by purchasesof
ofgoods
goods
purchases
households
households andservices
services
and

This equation is called the national income accounts identity

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 YY =
=CC+
+ II +
+GG+
+ NX
NX
• Consumption consists of the goods and services bought by househ
olds. It is divided into three subcategories: nondurable goods, durabl
e goods, and services.
• Investment consists of goods bought for future use. Investment is a
lso divided into three subcategories: business fixed investment, resi
dential fixed investment, and inventory investment. Note that invest
ment creates new capital.
• Government purchases are the goods and services bought by the
governments. It does not include transfer payments to individuals, s
uch as social security and welfare.
• net exports accounts for trade with other countries. Net exports are
the value of goods and services sold to other countries (exports) mi
nus the value of goods and services that foreigners sell us (imports).

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 3.1.7 Other Measures of Income
• To obtain gross national product (GNP), we add receipts of factor in
come (wages, profit, and rent) from the rest of the world and subtract
payments of factor income to the rest of the world.
• GNP = GDP + Factor Payments from Abroad - Factor Payments t
o Abroad
• GDP measures the total income produced domestically.
• GNP measures the total income earned by nationals (residents of a n
ation).

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• To obtain net national product (NNP), we subtract the depreciation
of capital—the amount of the economy’s stock of plants, equipment,
and residential structures that wears out during the year:
• NNP = GNP – Depreciation
• In the national income accounts, depreciation is called the consum
ption of fixed capital. It equals about 10% of GNP.
• Because depreciation of capital is a cost of producing the output of t
he economy, subtracting depreciation shows the net result of econo
mic activity.
• NNP is approximately equal to another measure called national inc
ome. The two differ by a small correction called the statistical discr
epancy, which arises because different data sources may not be co
mpletely consistent.

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 3.2. The Consumer Price Index
3.2.1 The Price of a Basket of Goods
• The increase in the overall level of prices is called inflation, and it is
one of the primary concerns of economists and policymakers.
• The most commonly used measure of the level of prices is the cons
umer price index (CPI).
• The CPI turns the prices of many goods and services into a single in
dex measuring the overall level of prices. A basket of goods and s
ervices purchased by a typical customer is chosen first. The CPI
is the price of this basket of goods relative to the price of the same b
asket in some base year.
• Core inflation measures the increase in the price of a consumer ba
sket that excludes food and energy products. Because food and
energy prices exhibit substantial short-run volatility, core inflation is
sometimes viewed as a better gauge of ongoing inflation trends.
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 Let’s see how the CPI would be computed in our apple and
orange economy.

For example, suppose that the typical consumer buys 5 apples and 2
oranges every month. Then the basket of goods consists of 5 apples and 2
oranges, and the CPI is:

CPI = ( 5  Current Price of Apples) + (2  Current Price of Oranges)

( 5  2009 Price of Apples) + (2  2009 Price of Oranges)

In this CPI calculation, 2009 is the base year. The index tells how much it
costs to buy 5 apples and 2 oranges in the current year relative to how much
it cost to buy the same basket of fruit in 2009.

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• CPI
 3.2.2 The CPI Versus the GDP Deflator
CPI Vs GDP deflator China 1993 - 2012
30
25
20 CPI annual %

15 GDP deflator annual %

10
5
0
-5

• The GDP deflator measures the prices of all goods produced, whereas the C
PI measures prices of only the goods and services bought by consumers. Thu
s, an increase in the price of goods bought only by firms or the government wi
ll show up in the GDP deflator, but not in the CPI.
• Another difference is that the GDP deflator includes only those goods and ser
vices produced domestically. Imported goods are not a part of GDP and there
fore don’t show up in the GDP deflator.
• The final difference is the way the two aggregate the prices in the economy. T
he CPI assigns fixed weights to the prices of different goods, whereas the GD
P deflator assigns changing weights. 45
 3.3 The Unemployment Rate

• Each adult (working age) can be placed into one of three categories:
1) Employed: those who at the time of the survey worked as paid empl
oyees, worked in their own or family business.
2) Unemployed: those who were not employed, but available for work
and had tried to find employment.
3) Not in the labor force: those who fit neither of the first two categorie
s, such as a full-time student, homemaker or retiree. A person who
wants a job but has given up looking—a discouraged worker—is c
ounted as not being in the labor force.

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• The labor force is defined as the sum of the employed and unempl
oyed.

• The unemployment rate is defined as the percentage of the labor f

orce that is unemployed.

• The labor-force participation rate is the percentage of the adult po

pulation that is in the labor force.

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