TOPIC 7

MACROeconomics
Chapter 12
1. What is macroeconomics?
2. What is GDP?

Growth and the business cycle

In the long run, the
Australian economy has
experienced economic
growth and rising living
standards, and in the short
run the economy has
experienced a series of
business cycles.

Macroeconomics

Microeconomics: The study of how households

and firms make choices & how they interact in
markets.
Macroeconomics: The study of the economy
as a whole, including topics such as inflation,
unemployment, and economic growth.
Macroeconomics is a study of the business
cycle
Business cycle: Alternating periods of economic
expansion and economic contraction relative to
trend growth

GDP and Economic Growth

Economic growth: The expansion of societys

productive potential - usually measured by the
rate of growth in real GDP.
Expansion: The period of a business cycle
during which total production and total
employment are increasing above trend growth.
Contraction: The period of a business cycle
during which total production and total
employment are falling below trend growth.
What is a recession?

GDP measures total production

Gross Domestic Product (GDP): The market

value of all final goods and services produced
in a country during a given period of time.

GDP does not includes the market value of

intermediate goods and services (goods
used as inputs, such as a tyre on a truck).
GDP includes only current production.
GDP does not include the value of used
(second-hand) goods.

Review
Which of the following headlines would be more
closely related to what macroeconomists study
than what microeconomists study?
A) Avocado prices rise due to a late frost in
Queensland.
B) The United Auto Workers sign a contract
raising wages 7% over the next 3 years.
C) Real GDP grows by 2.3% in the second
quarter.
D) Airlines raise ticket prices in response to rising
fuel costs.

Review
Which of the following goods is directly
counted in GDP?
A) the lettuce that Subway purchases for its
sandwiches
B) the bread that Subway purchases for its
sandwiches
C) a 12-inch Subway sandwich purchased by a
student
D) the plastic bags that Subway purchases to
wrap its sandwiches
7

Review
If you make dinner for yourself
A) the market value of your dinner is added to
GDP.
B) your service in preparing the meal is
valued at a cook's wage and added to GDP.
C) none of what you bought to prepare for
dinner is included in GDP.
D) only the market value of ingredients that
you purchased this year is added to GDP.
8

Calculating GDP

Assume a simple economy (Economy X)

which produces only three goods: TVs,
pizzas and espressos. Use the
information in the table below to calculate
GDP for this economy.
Production and Price Statistics for Economy X

Product
TVs
Pizzas
Espressos

Quantity

Price per unit ($)

50

1000

500

10

1000

Calculating GDP
Production and Price Statistics for Economy X
Product
Quantity Price ($)
Value ($)
50
1000
TVs
50,000
500
10
Pizzas
5,000
1000
4
Espressos
4,000
TOTAL (GDP): $59,000

Methods of measuring GDP

The Australian Bureau of Statistics
(ABS) uses three alternative methods
to measure GDP:
1. The production method
2. The expenditure method
2. The income method

11

Methods of measuring GDP

The circular-flow diagram shows the flow
of spending and money in the economy.
It illustrates the equality between GDP
measured from the income and
expenditure methods.
The income generated in the production
of goods and services is equal to the
value of expenditure on these goods and
services.
12

The circular flow and measurement of GDP

13

Components of GDP
Expenditure Method: The ABS divides GDP
into four major categories of expenditures on
Australian produced goods & services.
Spending by households: consumption (C)

Spending by firms: investment (I)

Spending by government: (G)

Spending by overseas: (X)

Some spending by households, firms &
government is on imports so this must be
subtracted from total spending

Components of GDP

Consumption (C): Spending by households

Non-durable goods food & clothing
Durable goods furniture, appliances, cars
Services health, education, leisure
(Note C does not include spending on new
houses.
Consumption is the largest category of GDP
What factors affect Consumption spending?
Which type of spending is more volatile
durable or non-durable goods?

Components of GDP

Investment (I): includes 3 categories

Business fixed investment spending by firms
on new factories, office buildings, machinery,
computers
Inventories goods produced but not yet sold
Residential investment spending by
households on new housing
What factors affect investment?
Investment is the most volatile category. Why?

Components of GDP

Government purchases (G): Spending by

federal, state, and local governments on goods
and services.
Can be divided into government C spending &
government I spending
Note: spending on transfer payments is not
included in G
Net exports (NX): The value of exports minus
expenditure on imports.
Exports are included because it is domestic
production
Imports are subtracted because it is foreign
production

Components of GDP

An equation for GDP (where Y = GDP or

total output):

Y = C + I + G + NX

Components of GDP, 2012/13

Consumption
Investment
Government
Net Exports
Exports
Imports
Total
Stat Disc.
TOTAL GDP
19

$ millions
815 073
360 374
337 321

Per cent
53
24
22

14 451
-1 778
1 525 441

334 716
320 265

100

900000
800000

GDP 2012-13
C

700000
600000
500000
$ millions
400000

300000
200000
100000
0

NX
Consumption Investment Government Net Exports

Does GDP measure what

we want it to measure?

What types of production are left out of

GDP?
1.

Household production: Goods and

services people produce for themselves.
Examples: Home cooking, cleaning, child care,
gardening.

2.

The black economy: Buying and selling of

goods and services that is concealed from
the government to avoid taxes or regulations
or because the goods and services are
illegal.

Does GDP measure what

we want it to measure?

1.

2.

GDP was designed to measure a

countrys production but it is often used
as a proxy to measure wellbeing
Is GDP a good measure of well being?
We need to be aware of the following
shortcomings of GDP:
The distribution of GDP is not captured in
GDP measures.
The value of leisure is not included in GDP.

Does GDP measure what

we want it to measure?
3.

4.

5.

The level, quality of, and access to health

care & education is not measured in GDP.
GDP is not adjusted for pollution or other
negative effects of production.
GDP is not adjusted for changes in crime
and other social problems

Real GDP versus Nominal GDP

It is important to separate a measured rise in
GDP that may be due only to price changes from
real quantity changes.

Nominal GDP: The market value of final goods

and services evaluated at current year prices.
Real GDP: The market value of final goods and
services evaluated at base year prices.
Nominal GDP can change over time due to
changes in either price or output.
Real GDP shows changes in output only.

Calculating Nominal & Real GDP

Our economy produces only three goods; TVs, pizzas

and lattes. Use the information in the table below to
calculate nominal GDP for this economy in year 2

Year 1

Year 2

Product
Qty
Price $ Value Qty
Price $
TVs
50
1000 50000
52
1000
Pizzas
500
10
5000
510
11
Espresso 1000
4
4000
1025
5
GDP
59000

Value
52000
5610
5125
62735

Calculating Nominal & Real GDP

Nominal GDP has increased by 6.3%

[(62,735 59,000) / 59,000 x 100]

Calculate real GDP for Year 2

How?

By multiplying the prices of each item for Year 1

times the quantity of all three goods for Year 2,
and then summing the three values.

Calculating Real GDP

Year 1
Product
TVs
Pizza
Espressos

Price ($)
1000
10
4

Year 2
Quantity
Value ($)
52
52000
510
5100
1025
4100
REAL GDP: $61 200

Nominal GDP increased by 6.3% but how much

has real GDP increased?
Growth rate = ($61,200 - $59,000) / $59,000 x 100

Real GDP has grown by 3.7%

Calculating the economic

growth rate
Example: Real GDP for Australia was:
2012-13: $ 1 525 283 million.
2013-14: $ 1 568 626 million.
Calculate the economic growth rate as
follows:
$1 568 626 m - $1 525 283 m = $43 343 m
43 343 /1 525 283 x 100 = 2.84%
Is this good, average or poor?

Australias Real GDP

Quarter Real GDP Qrtly Growth
$m
Rate
Jun 2013 384 535
Sep 2013387 203
0.7
Dec 2013390 419
0.8
Mar 2014394 541
1.1
Jun 2014 396 463
0.5
Annual growth rate: 3.1%
29

GDP Annual Growth

Rate
5

4.5

Target growth rate

4
3.5
3
2.5

Below trend
growth

2
1.5
1
0.5
0
40422
40603
40787
40969
41153
41334
41518
41699
40330
40513
40695
40878
41061
41244
41426
41609
41791

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Long-run economic growth is the

key to rising living standards

The ultimate goal for any economy is to

improve living standards over time.
Real GDP per capita is used to measure
changing living standards over time. Why?

Real GDP per capita, Australia, 19012010

7000
6000

Real GDP/capita has

increased 6 fold

1966-67 prices (dollars)

5000
4000
3000
2000
1000
0

Long-run economic growth is the

key to rising living standards
What determines the rate of long-run
growth?
Increases in real GDP per capita
depend on increases in labour
productivity.

33

Labour productivity: The quantity of

goods and services that can be

Long-run economic growth is the

key to rising living standards
Two key factors determine labour
productivity:

34

1.Increases in capital per hour

worked.
Capital: Manufactured goods that
are used to produce other goods and
services; examples include
computers, factory buildings, and
machines.

Long-run economic growth is the

key to rising living standards
2. Technological change: This is
change in the ability of a firm to
produce a given level of output with
a given quantity of inputs.

35

Accumulating more inputs such as

labour, capital, and raw materials
will not ensure that an economy
experiences economic growth
unless technological change also

Potential GDP

36

Potential GDP: The level of GDP

attained when all firms are producing
at capacity.
Potential real GDP increases every
year as the labour force & capital
stock increase & as technology
improves
Growth in potential GDP is estimated
to be approximately 3.5% per year.
Actual real GDP fluctuates around the

Actual and potential GDP, Australia, 19602011

350

Which graph represents potential GDP?

Which graph represents actual GDP?

300
Real GDP (billions of dollars)
250
200
150
100
50
0

37

Review
If you purchase a new car it would be
included in
A) consumption expenditures on services.
B) consumption expenditures on nondurable
goods.
C) consumption expenditures on durable
goods.
D) investment expenditures.

Review
The largest component of GDP in
Australia, as measured by the expenditure
method, is
A. consumption expenditure.
B. government expenditure.
C. net exports.
D. investment expenditure.

Review
Which of the following is an example of
the investment component of GDP?
A. You purchase shares in BHP.
B. You put money into your bank
account.
C. You put money into your savings
account.
D. BHP builds a new processing plant.

Review
When consumers are less confident about
their jobs or incomes, they are more likely to
A) reduce purchases of durable goods than
nondurable goods.
B) reduce purchases of nondurable goods
and increase purchases of durable goods.
C) increase investment spending and
decrease consumption spending.
D) increase consumption spending and
decrease investment spending.

Review
Real GDP will increase
A) only if the price level rises.
B) only if the price level falls.
C) only if the quantity of final goods and
services produced rises.
D) if either the price level rises or the
quantity of final goods and services
produced rises.