NOTES

ECON1102: Macroeconomics
University of New South Wales
Table of Contents
1 MEASURING MACROECONOMIC PERFORMANCE: OUTPUT AND PRICES 4
1.1 GROSS DOMESTIC PRODUCT (GDP) 4
1.2 NOMINAL VERSUS REAL GDP 4
1.3 IS REAL GDP THE SAME AS ECONOMIC WELL-BEING? 4
1.4 CONSUMER PRICE INDEX (CPI) 5
1.5 INFLATION 5

2 MEASURING MACROECONOMIC PERFORMANCE: SAVING AND WEALTH 6

2.1 KEY CONCEPTS 6
2.2 SAVING 6
2.3 WEALTH 6
2.4 REASONS FOR SAVING 6
2.5 SAVING AND THE REAL INTEREST RATE 6
2.6 NATIONAL SAVING 7
2.7 PRIVATE SAVING 7
2.8 PUBLIC SAVING 7
2.9 INVESTMENT 7
2.10 SAVING AND INVESTMENT 7

3 MEASURING MACROECONOMIC PERFORMANCE: UNEMPLOYMENT AND THE

LABOUR MARKET 9
3.1 LABOUR MARKET MODEL 9
3.2 SHIFTS IN THE DEMAND AND SUPPLY FOR LABOUR 9
3.3 GLOBALISATION 9
3.4 TECHNOLOGICAL CHANGE 10
3.5 UNEMPLOYMENT 10
3.6 COSTS OF UNEMPLOYMENT 10
3.7 TYPES OF UNEMPLOYMENT 10

4 SHORT-TERM ECONOMIC FLUCTUATIONS 11

4.1 CLASSICAL BUSINESS CYCLE 11
4.2 GROWTH CYCLE 11
4.3 OUTPUT GAPS 11
4.4 NATURAL RATE OF UNEMPLOYMENT 11
4.5 OKUNS LAW 11

5 SPENDING AND OUTPUT IN THE SHORT RUN 13

5.1 ASSUMPTIONS OF THE KEYNESIAN MODEL 13
5.2 AGGREGATE EXPENDITURE 13
5.3 CONSUMER SPENDING 13
5.4 TWO-SECTOR MODEL 13
5.5 INJECTIONS AND WITHDRAWALS 14
5.6 FOUR-SECTOR MODEL 14
5.7 THE MULTIPLIER 15

6 FISCAL POLICY 16
6.1 FISCAL POLICY AND OUTPUT GAPS 16
6.2 EFFECTS OF DIFFERENT FISCAL INSTRUMENTS 16
6.3 LIMITATIONS OF FISCAL POLICY 16
6.4 PUBLIC DEBT AND GOVERNMENT BUDGET CONSTRAINT 17

7 MONEY, PRICES AND THE RESERVE BANK 18

7.1 MONEY 18
7.2 MEASURING MONEY 18
7.3 COMMERCIAL BANKS AND CREATION OF MONEY 18
7.4 MONEY AND PRICES 19
7.5 THE RESERVE BANK OF AUSTRALIA (RBA) 19

8 THE RESERVE BANK AND THE ECONOMY 20

8.1 MONEY SUPPLY AND DEMAND MODEL 20
8.2 CAN THE RBA CONTROL REAL INTEREST RATE? 21
8.3 PAE AND THE REAL INTEREST RATE 21
8.4 POLICY REACTION FUNCTION 21

9 AGGREGATE DEMAND AND AGGREGATE SUPPLY 22

9.1 AGGREGATE DEMAND 22
9.2 AGGREGATE SUPPLY 22
9.3 SHOCKS TO THE AD CURVE 23
9.4 SHOCKS TO THE AGGREGATE SUPPLY 23

10 EXCHANGE RATE AND THE OPEN ECONOMY 25

10.1 IMPORTANT TERMS 25
10.2 NOMINAL AND REAL EXCHANGE RATES 25
10.3 PURCHASING POWER PARITY (PPP) 25
10.4 SUPPLY AND DEMAND MODEL FOR EXCHANGE RATE 26
10.5 FIXED EXCHANGE RATES 26
10.6 ADVANTAGES OF EACH SYSTEM 26

11 NET EXPORTS AND INTERNATIONAL CAPITAL FLOWS 27

11.1 BALANCE OF PAYMENTS 27
11.2 RELATIONSHIP BETWEEN THE CAPITAL AND CURRENT ACCOUNTS 27
11.3 DETERMINANTS OF INTERNATIONAL CAPITAL FLOWS 27
11.4 SAVING, INVESTMENT AND CAPITAL INFLOWS 28

12 THE ECONOMY IN THE LONG RUN: ECONOMIC GROWTH 29

12.1 REAL GDP PER CAPITA 29
12.2 DETERMINANTS OF AVERAGE LABOUR PRODUCTIVITY 29
12.3 COSTS OF ECONOMIC GROWTH 29
12.4 THE PRODUCTION FUNCTION COBB DOUGLAS 29
12.5 GROWTH ACCOUNTING 30
1 Measuring Macroeconomic Performance: Output
and Prices
A macro economy is performing well when it meets these requirements:
1. Rising living standards Increases in output in the long run.
2. Avoiding extremes of macroeconomic performance Avoiding large
expansions and contractions.
3. Maintaining the real value of currency Stable inflation rate in the
long run.
4. Ensuring sustainable levels of public and foreign debt Keep debt
levels at a manageable level.
5. Balancing current expenditure against saving current consumption
versus saving for future consumption.
6. Providing employment for all individuals seeking work Maintain a
low unemployment rate.

1.1 Gross Domestic Product (GDP)

The market value of final goods and services produced in a
country during a given time period.
How to calculate:
1) Production method Summing up the market value of all final
goods and services product domestically.
2) Expenditure method Adding up the amount spent by
purchasers on final goods and services produced domestically.
3) Income method Adding up the revenue distributed to labour
and capital as a result of selling final goods and services
produced domestically.

1.2 Nominal versus real GDP

Nominal GDP values quantities produced at current-year prices
(current quantity multiply by current-year prices).
Real GDP values quantities produced at base-year prices (current
quantity multiply by base-year prices).

1.3 Is real GDP the same as economic well-being?

No, as real GDP does not take into account:
1) Leisure time
 2) Non-market economic activities such as volunteering
3) Environmental considerations
4) Quality of life such as low crime rates
5) Economic inequality Does not show how GDP is distributed
But generally higher real GDP means better economic well-being.

1.4 Consumer Price Index (CPI)

Measures the cost of a standard set of goods and services for
a given time period relative a based year (fixed year).

1.5 Inflation
The annual percentage change in price level.

( 1 )
"" =
1
Main costs of inflation:
1) Shoe-leather costs Increase trips to bank for interest to
negate inflation.
2) Noise in the price system Unsure if increased prices means
more demand or inflation coming into play.
3) Distortions of the tax system Lower nominal income due to
higher tax paid.
4) Unexpected redistribution of wealth Unexpected transfer of
wealth.
5) Interference with long-run planning Inflation is sometimes
unpredictable.
6) Menu costs Need to reprint menu every time inflation occurs.
NOTES
MATH1002: Linear Algebra
The University of Sydney

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