Prof.

Fei DING
The Hong Kong University of Science and Technology

ECON 2123: Macroeconomics

OVERVIEW AND KEY CONCEPTS

RECAP: ECONOMICS STUDIES HOW …

 We use scarce resources to improve our well-being;

 Our economic decisions affect others in the society;
 Government policies influence our economic decisions.

 Resources are scarce  need to make choices.

 Scientific method  need to measure things.
 World is complicated  need to use models.

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MACRO MORE DIFFICULT THAN MICRO!

 Macroeconomics considers a group of

individuals as an unit together in the
 Short run (a few years),
 Medium run (a decade),

 Long run (a few decades or more).

 Three key variables in macroeconomics

 Output
 Unemployment rate

 Inflation rate

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 Ch1: A Tour of the World
Ch2: A Tour of the Book

LEARNING OBJECTIVES
 Obtain a big picture of the macro economy around the world: US, EU, and China.
 Define output, unemployment, inflation.
 Understand the components of the national income and product accounts.
 Understand key terms at the end of Ch2.

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HOW TO DESCRIBE AN ECONOMY?

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 CHINA VS. THE UNITED STATES
Table 1-4 Growth, Unemployment, and Inflation in China, 1990–2015

Table 1-1 Growth, Unemployment, and Inflation in the United States, 1990–2015

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 CHINA VS. THE EURO AREA
Table 1-4 Growth, Unemployment, and Inflation in China, 1990–2015

Table 1-3 Growth, Unemployment, and Inflation in the Euro Area, 1990–2015

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CHINA

 Astonishing growth!
 Since 1980, Chinese output has grown at close to 10% per year (compared
to 3.1% for the US over the same period).
 At this rate, output doubles every 7 years!
 Low unemployment.
 Inflation was high before 2000, but has stayed low ever since.
 Almost no sign of the global financial crisis. 8
THE CRISIS
Figure 1-2 Stock prices in the US, the Euro area, and emerging economies, 2007–2010

Table 1-1 (6th ed) World Output Growth since 2000

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LET’S SUMMARIZE

When looking at an economy, we first look for

three key variables:
 Output
 Unemployment rate
 Inflation rate
But what exactly are they, and how are they
calculated?

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“AGGREGATE” OUTPUT – GDP

 Aggregate means “total” in macroeconomics.

 GDP – Gross Domestic Product
 Measured by national income and product
accounts – an accounting system used to
measure aggregate economic activity.
 Precision and consistency
 Refer to Appendix 1 at the end of the textbook for
more details.
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HOW IS GDP CALCULATED?
Steel Company (Firm 1) Car Company (Firm 2)
Revenues from sales $100 Revenues from sales $200
Expenses $80 Expenses $170
Wages $80 Wages $70
Steel Purchases $100
Profit $20 Profit $30

GDP=?
1) $300 (=$100+$200) This is double counting of intermediate goods.

2) $50 (=$20+$30) This is capital (or profit) income, not total output.

3) $200 =$100+($200-$100)
=$80+$20+$70+$30
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GDP EXAMPLE
Steel Company (Firm 1) Car Company (Firm 2)
Revenues from sales $100 Revenues from sales $200
Expenses $80 Expenses $170
Wages $80 Wages $70
Steel Purchases $100
Profit $20 Profit $30

GDP = $200
1) Value of final goods, which aim for final consumption.
2) Value added – the value of production minus the value of
intermediate goods used in production. Intermediate goods aim for use
in the production of something else.
3) Sum of incomes – mostly labor income and capital income (and
indirect/sales taxes).
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HOW IS GDP CALCULATED?
 From the production side,
 Value of the final goods and services produced
domestically
 Sum of value-added in the domestic economy

 From the income side,

 Sum of incomes earned by domestically-located
factors of production
during a given period.

Aggregate Production = Aggregate Income

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REFRESH

A firm’s value added equals:

1. its revenue minus its costs.
2. its revenue minus its wages.
3. its revenue minus its wages and profit.
4. its revenue minus its cost of intermediate goods.
5. none of the above.

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NOMINAL VS. REAL GDP

 Nominal GDP is measured in current prices.

 Problem: prices of most goods increase over time.
 Want to measure output and its change over time
without the effect of increasing prices.
 Real GDP is measured in constant prices.
 Can use prices in a base year as common prices
Quantity Price Nominal Real GDP
Year of Cars of cars GDP (in 2005 dollars)
2004 10 $20,000 $200,000 $240,000
2005 12 $24,000 $288,000 $288,000
2006 13 $26,000 $338,000 $312,000
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NOMINAL VS. REAL GDP – US
Figure 2-1 Nominal and Real U.S. GDP, 1960–2014

From 1960 and 2014, nominal GDP increased by a factor of 32. Real GDP
increased by a factor of about 5.
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REAL GDP – COMPLICATIONS
 In the base year, nominal GDP = real GDP.
 The base year is chosen by convention.
 What about changes in the quality of existing goods?
 Hedonic pricing (see Ch2 focus box)
 More than one good, real GDP is a weighted average
of the output of all final goods.
 Relative prices determine the weights.
 But relative prices change over time!
 Use real GDP in chained (2005) dollars.
 Refer to the appendix at the end of Ch2 for details.
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GDP LEVEL VS. GROWTH RATE
 Real GDP per capita is the ratio of real GDP to the
population of the country.
 GDP measures economic size; GDP per capita measures
standard of living.
(Yt  Yt 1 )
 GDP growth: rate of growth of real GDP
Yt 1
 Negative growth  recession

 Positive growth  expansion

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US GDP GROWTH
Figure 2-2 Growth Rate of U.S. GDP, 1960–2014

Since 1960, the U.S. economy has gone through a series of expansions, interrupted by
short recessions. The 2008−2009 recession was the most severe recession in the
period from 1960 to 2014.
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THE GLOBAL RECESSION
Figure 1-1 Output Growth Rates for the World Economy, for Advanced
Economies, and for Emerging and Developing Economies, 2000–2014

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WHAT GDP MISSES …
 Goods and services without market prices
 Government services
 Owner-occupied housing (partly accounted for)

 Goods and services that are not traded in

markets
 Leisure
 Housework

 Depletion of natural and environmental

resources
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WHAT GDP CAN AND CANNOT MEASURE

 Measure aggregate economic activities,

growth, standard of living
 Goods and services available for consumption
 Consumers’ valuation on these items
 Good measure of the material life?
 Not a measure of
 Environmental and emotional well-being
 Reading: Singapore, Hong Kong face happiness
deficit – SCMP, Jan. 19, 2013
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QUOTE OF THE DAY

“Yet the Gross National Product does not allow for the health of our
children, the quality of their education, or the joy of their play. It
does not include the beauty of our poetry or the strength of our
marriages, the intelligence of our public debate or the integrity of
our public officials. It measures neither our wit nor our courage,
neither our wisdom nor our learning, neither our compassion nor
our devotion to our country; it measures everything, in short, except
that which makes life worthwhile.”
Robert F. Kennedy

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WHAT IS UNEMPLOYMENT?
 Employment (N) is the number of people who have a job.
 Unemployment (U) is the number of people who do not have a
job but are looking for one.
 Discouraged workers are those without jobs who give up looking for work.
 The labor force L = N + U.
 Participation rate = L/total population of working age
 The unemployment rate u = U/L.
 We care about unemployment because
 It directly impacts the welfare of the unemployed.
 It means we are not using resources efficiently.

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UNEMPLOYMENT RATE – US
Figure 2-3 U.S. Unemployment Rate, 1960−2014

• Since 1960, the U.S. unemployment rate has fluctuated between 3 and 10%, going
down during expansions and going up during recessions.
• The effect of the recent crisis is highly visible, with the unemployment rate reaching
close to 10% in 2010, the highest such rate since the early 1980s.
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REFRESH
When an economy slows down, we often observe:
1) Low unemployment rate and high participation
rate.
2) Low unemployment rate and low participation
rate.
3) High unemployment rate and high participation
rate.
4) High unemployment rate and low participation
rate.

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THE INFLATION RATE

 Inflation is a sustained rise in the general level

of prices – the price level.
 Inflation rate is the growth rate of the price level.
 Deflation is a sustained decline in the price level,
i.e., negative inflation.
 We care about inflation because
 Inflation affects income distribution and welfare.
 Inflation leads to uncertainty and other distortions.

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HOW TO MEASURE INFLATION

 From the average price of output produced:

 The GDP deflator

 From the average price of consumption:

 The consumer price index (CPI)
 What’s the difference?
 Goods sold to firms, government, foreigners
 Goods imported from abroad

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HOW TO MEASURE INFLATION
 Both GDP deflator and CPI are index numbers.
 Level set to 100 in the base year. Level has no
economic meaning.
 Their rate of change defines the inflation rate.

Figure 2 - 4
U.S. Inflation Rate, using
the CPI and the GDP
deflator, 1960-2010
The inflation rates, computed
using either the CPI or the
GDP deflator, are largely similar.

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GDP DEFLATOR EXERCISE
Nominal Real GDP GDP Inflation
Year GDP (in 2005 dollars) Deflator Rate
2004 $200,000 $240,000 ? N.A.
2005 $288,000 $288,000 ? ?
2006 $338,000 $312,000 ? ?

 Compute the GDP deflator for each year.

 Compute the inflation rate from 2004 to 2005, and

from 2005 to 2006.

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STYLIZED FACTS IN MACROECONOMICS
 Unemployment rises during recessions and
falls during expansions.
 Okun’s Law: negative relationship between GDP
growth and change in unemployment rate.

Figure 2-5 Changes in the

unemployment rate versus
output growth in the United
States, 1960–2010

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STYLIZED FACTS IN MACROECONOMICS
 On average, higher (lower) unemployment
leads to a decrease (increase) in inflation.
 Phillips Curve: negative relationship between
unemployment rate and change in inflation rate.

Figure 2-6 Changes in the

inflation rate versus the
unemployment rate in the
United States, 1960–2010

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Macroeconomics Facts of Hong Kong
GDP, INFLATION RATE, UNEMPLOYMENT RATE

Where to find Data

Census and Statistics Department:

www.censtatd.gov.hk
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CH2 QUICK CHECK (TEXTBOOK)
True or False?
(a) When the unemployment rate is high, the participation
rate is also likely to be high.
(b) The rate of unemployment tends to fall during expansions
and rise during recessions.
(c) If the Japanese CPI is currently at 108 and the U.S. CPI is
at 104, then the Japanese rate of inflation is higher than
the U.S. rate of inflation.
(d) The rate of inflation computed using the CPI is a better
index of inflation than the rate of inflation computed
using the GDP deflator.
(e) The Phillips curve is a relation between the level of
inflation and the level of unemployment.
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SEE YOU NEXT TIME 

 Assigned reading:
 Textbook Chap. 1 and 2 (exclude appendix)
 Textbook, Chap. 3 (for next time)
 Problem set 1 will be posted soon.
 Make sure you can submit PS0 via CANVAS.

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