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Chapter 1IntroductionWhat is Macroeconomics?Macroeconomics focuses on the aggregate behavior of consumers and firms the behavior of government the overall level of economic activity in individual countries the economic interactions among nations the effects of fiscal and monetary policies Macroeconomics differs from microeconomics in that it deals with the overall effects on economics of the choices that all economic agents make,rather than on the choices of individual consumers or firms.Long-run growth refers to the increase in a nations productive capacity and average standard of living over a long period of time.Business cycles refer to the short-run ups and downs in aggregate economic activity.Gross National Product,Economic Growth and Business CyclesThe most basic set of facts in macroeconomics has to do with the behavior of aggregate economic activity over time.One measure of aggregate economic activity is gross national product(GNP).The series of real GNP per capita for the U.S.over the period 1900-2002 is shown in the figure.Two Useful Transformation of Data1)Taking natural logarithm of time series.The slope of the graph of the natural logarithm of a time series yt is a good approximation to the growth rate of yt when the growth rate is small.Since if yt yt-1,we have.loglog111tttttyyyyy2)Detrending the process of decomposing the series into 2 components:the growth(or trend)component,and the business cycle component.The trend in the log of real per capita GNP is shown as a colored line,while the log of actual real per capita GNP is the black one.The lower graph shows only the percentage deviations from trend in real per capita GNP.Macroeconomic Models Purpose:To capture the essential features of the world needed for analyzing a particular economic problem.To be useful then,a model must be simple.Basic structure of a macroeconomic model:The consumers and firms in the economy,who are assumed to optimize The sets of goods that consumers wish to consume Consumers preferences over goods The technology available to firms for producing goods The resources available Competitive Equilibrium:all agents(consumers and firms)act as price-takers,and prices clear markets.Microeconomic PrinciplesMacroeconomic behavior is the aggregation of microeconomic decisions made by all the consumers and firms in the economy.Very often,we are interested in the macroeconomic effects of a policy change.In particular,we want to make predictions on those effects that are consistent with individual decisions.To achieve this,we must work our way up from decision making at the micro-level,then aggregating these decisions to arrive at the macroeconomic effects of the policy change.Disagreement in Macroeconomics There is little disagreement in macroeconomics concerning the general approaches to modeling growth.There is much controversy concerning business cycle theory and the role of the government policy in smoothing out cycles:Keynesian Sticky-Price Theory(Keynes,Hicks&Samuelson)Money Surprise Theory(Friedman&Lucas)Real Business Cycle Theory(Prescott&Kydland)Keynesian Coordination Failure Theory(Diamond,Cooper&John)Chapter 2Measurement Measuring Gross Domestic Product(GDP)National Income Accounting is a process of measuring the total quantity of goods and services produced for the market in a given country over a given period of time.Gross Domestic Product(GDP)is the dollar value of final output produced during a given period of time within a country.There are 3 distinct approaches to measure GDP:Product Approach Expenditure Approach Income Approach Product approach:GDP is the sum of value added to goods and services in production across all productive units in the economy.Remarks:the value of intermediate goods used in production must be subtracted from the value of all goods produced in the economy,if not there would be double-counting.Expenditure approach:GDP is the total spending on all final goods and services production in the economyTotal expenditure=C+I+G+NX Income approach:GDP can be computed by adding up all incomes received by economic agents contributing to production.Incomes include:compensation of employees,proprietors income,rental income,corporate profits,net interest,indirect business taxes and depreciation.A common measure of aggregate output is GNP.Gross National Product(GNP)measures the value of output produced by domestic factors of production,whether or not the production takes place inside the countrys borders.GNP=GDP+Net factor payments from abroad to domestic residents Numerical Example 1Consider an economy consisting of a coconut producer,a restaurant,consumers and a government.Coconut is both an intermediate good in the restaurant and a final consumption good.Current year production of coconuts=10 millionUnit Price of coconut=$2.00 After-tax profits=$13 million.Quantity of coconuts used by the restaurant as intermediate good=6 million Other data for the restaurant:After-tax profit=$11 million.Suppose that the government uses all the tax revenue to provide national defense.Also,for the consumers,we haveMethods of Computing GDP:The Product ApproachMethods of Computing GDP:The Expenditure ApproachMethods of Computing GDP:The Income ApproachLimitations of Using GDP1)GDP is inaccurate in measuring aggregate economic welfare because It does not take into account how income is distributed within the population.It leaves out all nonmarket activity,such as home production.2)GDP is also inadequate in measuring aggregate output because Underground economic activities are not counted in GDP,for example drug dealings,baby-sitting etc.It is difficult to estimate the exact value of government production.Nominal and Real GDP and Price IndicesVery often,we would like to compare the GDP data in different time periods.Since the average level of prices changes over time,an additional step is needed to disentangle a nominal change in GDP from a real change in GDP.A nominal change in GDP is a change in GDP that occurred only because the price level changed.A real change in GDP is an increase in the physical quantity of output.Numerical Example 2Consider an economy in which there are only 2 goods:apples and oranges.Nominal GDP in Year 1=$1*50 +$0.8*100=$130.Nominal GDP in Year 2=$1.25*80+$1.6*120=$292.%change in nominal GDP=If we use Year 1 as base year,i.e.to compute real GDP using Year 1 prices,then Real GDP in Year 1=Nominal GDP in Year 1,Real GDP in Year 2=$1*80+$0.8*120=$176,and%change in real GDP is 35.4%.If we repeat the above computations but using Year 2 as base year,then the%change in real GDP is 31.2%.Problem:If the relative price of apples to oranges changes over time,then the choice of base year matters for the calculation of GDP(as shown in the above example).%225%100*130$130$292$Solution:A chain-weighting scheme for calculating real GDP.Step 1:Compute the ratios of real GDP in year 2 to real GDP in year 1 using different base years:Year 1 as base year:g1=176/130=1.354,Year 2 as base year:g2=292/222.5=1.312.Step 2:Calculate the chain-weighted ratio of real GDP:g=(g1*g2)1/2 =(1.354*1.312)1/2=1.333.Step 3:Calculate the%change in real GDP:%change in real GDP is 33.3%.Step 4:Calculate real GDPs:Year 1 Base:130 and 173.29(130*1.333),Year 2 Base:219.05(292/1.333)and 292.Measures of Price LevelA price index is a weighted average of the prices of a set of the goods and services produced in the economy over a period of time.Two common measures of the price level:Implicit GDP price deflator100*GDP RealGDP Nominaldeflator price GDPImplicit Consumer Price Index(CPI)It is a fixed-weight price index,which takes the quantities in some base year as being the typical goods bought by the average consumer during that base year,and then uses those quantities(same basket)as weights to calculate the index in each year.100*pricesyear baseat quantitiesyear base ofCost pricescurrent at quantitiesyear base ofCost CPIyear Current Problems with Measuring Real GDP and Price Level In computing the CPI,we implicitly assume that consumers buying habits are unaffected by a relative price change.This may not be realistic because consumers typically will purchase less of the goods that have become more expensive(substitution effects).As a result,these goods receive a higher weight than they should in the CPI,and thus the CPI-based measure of the rate of inflation will be biased upward.In measuring real GDP,changes in the quality of goods over time is not taken into account.As a result,inflation and growth in real GDP will be biased.A third problem is how measured GDP takes account of new goods,e.g.the appearance of personal computers.Saving,Wealth and CapitalSaving is a flow,i.e.a rate per unit time,while wealth is a stock,i.e.the quantity in existence at a point in time.Let Yd denote private disposable income.Y is GDP,NFP is net factor payments from abroad to domestic residents,TR is transfer from the government to the private sector,INT is interest on the government debt,and T is taxes.TINTTRNFPYYdPrivate sector saving,Sp,is given by Yd-C.Government saving Sg is given by government surplus(deficit).The sum of Sp and Sg is called national saving,denoted by S,The quantity NX+NFP is the current account surplus(CA)with the rest of the world.This is a measure of the balance of trade in goods with all other countries.If S I,then CA 0,i.e.the excess domestic savings must be shipped outside the country in the form of goods and services.GINTTRTSg00gSNFPNXISLabor Market MeasurementThe following classification is adopted by the U.S.Bureau of Labor Statistics,employed:those who worked part-time or full-time during the past week,unemployed:those who were not employed during the past week,but actively searched for work at some time during the last four weeks,and not in the labor force:those who are neither employed or unemployed.Labor Force=no.of the employed+no.of the unemployed.Two key statistics:Unemployment rate may not be an ideal measure of labor market tightness because discouraged workers,namely those who have stopped searching for work but actually wish to be employed,are not counted in the labor force,the unemployment rate does not adjust for how intensively the unemployed are searching for work.forceLabor unemployedNumber Ratent Unemploymepopulation age workingTotalforceLabor Rateion ParticipatChapter 3Business Cycle MeasurementRegularities in GDP Fluctuations Business Cycles:fluctuations about trend in real GDP.Peak(Trough):a relatively large positive(negative)deviation from trend.Peaks and troughs are referred to as turning points.Regularities in GDP Fluctuations Amplitude:the maximum deviation from trend.Frequency:the number of peaks in real GDP that occur per year.Observations from the U.S.Data Consider the percentage deviations from trend in real GDP over the period 1947-2003.3 main observations:*Persistency*Irregularities*ComovementObservations from the U.S.Data Persistency:the deviations from trend are persistent in the sense that when real GDP is above(below)trend,it tends to stay above(below)trend.This is important for making economic forecast over the short run.Observations from the U.S.Data Irregularities:irregularities in the amplitude and frequency of fluctuations in real GDP about trend.These imply that forecasting is difficult for longer term.Observations from the U.S.Data Macroeconomic variables usually fluctuate together in patterns that exhibit strong regularities:Comovement 3 ways of describing comovement relative to real GDP:Procyclical,countercyclical,acyclical Leading,lagging,coincident Variability relative to GDP Procyclical variable:if its deviations from trend are positively correlated with the deviations from trend in real GDP.Examples:real consumption,real investment,real imports,money supply,employment and real wage.Countercyclical variable:if its deviations from trend are negatively correlated with the deviations from trend in real GDP.Example:price level Acyclical variable:if it is neither procyclical or countercyclical.Degree of correlation between two variable x and y is measured by the correlation coefficient,takes on values between-1(perfectly negatively correlated)and 1(perfectly positively correlated).yxyxCovvarvar,Leading and Lagging Leading variable:its peaks and troughs tend to precede those of real GDP.This kind of variable tends to aid in predicting the future path of real GDP Example:money supplyLeading and Lagging Lagging variable:its peaks and troughs tend to lag before those of real GDP.Contrary,real GDP helps to predict the future path of such a variable.Coincident variable:one that is neither leads nor lags real GDP.Examples:real consumption(see fig.)real investment price levelLeading and LaggingVariability relative to GDP Variables that are more volatile than real GDP:real investment,real imports Variables that are less volatile than real GDP:real consumption,price level,money supply and employment Cyclical variability is measured by the standard deviation of the percentage deviations from trend.
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