Lecture 1: Introduction

January 31, 2005

References for rst half of the course

1. Mankiw, N.G, Macroeconomics, Fifth edition chapter 2: Data of Macroeconomics chapter 3: the goods market chapter 5: open economy chapter 4: money and ination chapter 6: unemployment 2. Blanchard, O, Macroeconomics, Third edition 3. Weil, D, Economic Growth chapter 1: the facts to be explained chapter 3: capital accumulation chapter 4: population chapter 6: human capital

chapter 7: measuring productivity

chapter 8: cutting edge of technology

Introduction
Macroeconomics is dened as the study of the economy as a whole: its aggregate output (total GDP), its output per capita (productivity), its total consumption, its total investment, its total government expenditure, its unemployment rate, its total imports and exports, its aggragate money supply and demand, its aggregate price index, its ination rate, its interest rate(s), and the evolution of these variables over time; the average growth rate and its determinants. Questions that macroeconomics tries to answer:

1. Why do some countries grow fast while other stagnate, and why do some countries catch up with the most advanced countries and other countries diverge from the frontier? What can governments do to foster long-run growth and convergence? 2. Why do some countries experience high rates of ination while others maintain stable prices? 3. Why do all countries experience booms and slumps and what can governments do to reduce frequency and magnitude of slumps? Microeconomics is the study of how households and rms make decisions (individual demand, production, investment, R&D, organization,..) and how these decisions interact in the market place each agent maximizes objective subject to budget or technological constraint macroeconomics may either abstract from these optimization decisions altogether, or assume that the economy is behaving like a representative consumer and a representative producer, or aggregate among heterogeneous agents In the rst part of the course, I will assume exible price and market clearing, whereas Francesco Caselli who concentrates more on the short run, will assume price rigidity.

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3.1

The Data of macroeconomics

Measuring aggregate output: nominal versus real GDP
1. total income of everyone in the economy 2. total expenditure on the economys output of goods and services the two are equal simply because every transaction has both, a buyer and a seller: every dollar of expenditure by a buyer must become a dollar of income to a seller. When Joe paints Janes house for 1,000$ that 1,000$ is income to Joe and expenditure to Jane. The transaction contributes 1,000$ to GDP regardless of whether we are adding up all income or adding up all expenditure. gure 2-1 Problem of aggregating between several goods and services 1. How can we add apples to oranges? we use market prices to weight quantities X GDP = pk qk 2 Two ways to look at GDP

but GDP does not include the sale of used goods (like paintings,...)

2. Treatment of inventories: suppose a rm has produced too much, and ends up this period with unsold goods if the good depreciates, then the amount of overproduction does not enter GDP (total expenditure in the economy has not changed because no one buys the bread, total income has not changed either, only its distribution between wages and prots) if the good does not depreciates, then it is counted as an increase in GDP (it has taken additional wage to produce the extra amount, hence more income is generated, and rms have spent more to raise inventory, so more expenditure has also raised) next period, the sale of this inventory will not be counted as yet additional GDP, as the inventory good is treated a used good (there is positive spending by bread consumers but negative spending by rms who are reducing their inventories, and one compensates the other) overall, GDP reects economys current production of goods and services 3. Intermediate goods GDP only includes the value of nal goods: the reason is that the price of the nal good already includes the value of intermediate goods, and we want to avoid double counting GDP is also equal to total value added of all rms in the economy, where V A = value of rms output value of rms int. inputs From nominal to real GDP 1. Nominal GDP is not a good measure of economic well-being, as a doubling in all prices would double GDP without corresponding to any increase in aggregate consumption 2. Real GDP is the value of goods and services using a constant set of prices X Real GDP = p0k qk 3. GDP deator GDP Deator = Nominal GDP Real GDP

this deator reects what is happening to the overall level of price in the economy between two periods 4. Example: one good economy Nominal GDP = P.Q 3

Real GDP = Pbase .Q = GDP Deator = P Pbase

5. Chain-weighted measures: average prices in 2001 and 2002 are used to measure real growth from 2001 to 2002, average prices in 2002 and 2003 are used to measure real growth from 2002 to 2003,... Components of expenditure 1. Consumption: goods and services bought by households (nondurable goods, durable goods, services) 2. Investment: goods bought for future use (business xed investment, residential xed investment, inventory investment) 3. Government purchases: goods and services bought by federal, state, and local governments (includes military equipment, highways, services provided by government workers); does not include transfers such as Social security and welfare (these only reallocate existing income) 4. Net exports: value of goods and services exported to other countries minus value of goods imported from other countries, or equivalently, net expenditure from abroad on our goods and services, which provides income to domestic producers. = Y = C + I + G + N X.

3.2

Measuring the cost of living: the CPI

CPI considers a xed basket of good, and measures how its average cost varies over time: P pk qok , CP I = P p0k qok where (q0k ) is the reference basket of goods. By contrast: P pk qk . GDP Deator = P p0k qk

CPI is also referred to as Laspeyres index, GDP Deator is also referred to as Paasche index. Main dierences between the two price indexes: 1. GDP deator measures the price of all goods and services produced, whereas CPI measures the price of only those goods and services that are bought by consumers; 4

2. GDP deator includes only those goods produced domnestically, whereas CPI includes imported goods; 3. CPI assigns xed weights to the prices of dierent goods, whereas GDP deator assigns changing weights. example of frost destroying orange crop; quantity of oranges produced falls down to zero, price of oranges increases very sharply; as a result CPI index increses but GDP deator is not aected sinces oranges are no longer part of GDP; 4. CPI overstates the impact of the increases in orange prices, as it ignores consumers ability to substitute apples for oranges; by contrast, GDP deator understates the impact on consumers, as it shows no rise in prices while surely higher price of oranges made consumers worse o.

3.3

Measuring joblessness: unemployment rate

Labor force: Labor Force = # of Employed + # of Unemployed; Unemployment rate: U= # of Unemployed .100; Labor Force

Labor Force Participation Rate: LF P R = Okuns Law: Labor Force .100. Adult Population

Increases in Unemployment Rate are associated with decreases in real GDP: % Real GDP = 3% 2.U.