Welcome to Macroeconomic Principles

Lecturer: Dr. Yixiao Zhou

Office: 408.3016
Consultation: Friday: 9-11am

Phone: +61 8 9266 7305

Email: yixiao.zhou@curtin.edu.au

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 Key Learning Outcomes
• Describe and investigate the questions that
macroeconomists seek to answer
• Understand the business cycle in the short run
• Apply and explain the AD/AS model to analyse
the global business cycle
• Evaluate the use of macroeconomic policies to
modify the business cycle

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Learning Resources
• Lecture and tutorial materials
• Key points that you need to know well.
• Help approach topics in order to succeed in this unit.
• Textbook (essential)
• Mishkin, Frederic S. (2015). Macroeconomics: Policy and
Practice, Global Edition, Second edition, Pearson
Education (myeconlab edition)
• Additional resources recommended
• Web links to recent policy issues that you may be interested
to know.
• Wider exposure to how concepts are applied to real life
macroeconomic policy issues.
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Topic 1: The Policy and Practice of
Macroeconomics—an introduction

Chapters 1 & 2 of textbook

Unit Coordinator: Dr. Yixiao Zhou

Contact: yixiao.zhou@curtin.edu.au

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 1. Why Macroeconomics is relevant
• Macroeconomics will inform us about
– Whether you will get a job when you graduate and
how well you will perform in your career in the long
term
– Whether the rate of inflation will be high or low
– How fast the economy will grow
– Whether the exchange rate will be high or low
– Whether interest rates will be high or low
– Whether government debt levels will be high or low

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 1. The Practice of Macroeconomics

• Macroeconomics is the study of economic

activity and prices in the overall economy
– Deals with aggregates such as total production
(GDP), unemployment across the entire
economy, and total consumption
• Macroeconomic research draws on
microeconomics, which looks at the behavior
of individual firms, households, or markets

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 1. The Practice of Macroeconomics

• Macroeconomics is concerned with two basic

questions
1. Why do economies grow over time?
2. Why do economies experience business cycles?
• Question 1 deals with the very long run –
growth theory
• Question 2 deals with the short run – applying
the AD/AS model to explain the business cycle

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 1. The Process: Developing
Macroeconomic Models
• Macroeconomists explain how the overall economy
works by using an economic theory—a logical
framework to explain a particular economic
phenomenon
• Macroeconomics is about building models to
understand why macroeconomic events like
recessions and high inflation have happened.
• Economic models are simplified theories that show
the key relationships among economic variables

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 1. The Process: Developing
Macroeconomic Models

• Models have two kinds of variables –

endogenous & exogenous variables.

– Endogenous variables – variables that the model

within
tries to explain, these are explained ________
the model

– Exogenous variables – the inputs into the model,

the explanatory factors, these are explained
outside the model
________
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 1. Variables in Macroeconomic Models

Exogenous variables Endogenous variables

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 1. Macroeconomic Models

• An economist creates an economic model, trying to

understand the behaviour of investment. She uses
short term interest rates, a measure of business
confidence, and total income as explanatory
variables.
• The endogenous variable(s) is/are
_____________________________
investment
• The exogenous variable(s) is/are

short term interest rates, business confidence, and

_____________________________
total income
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 2. Interpreting Macroeconomic Data

• Macroeconomists focus in particular

on three key economic data series:
– real GDP
– unemployment rate
– inflation rate

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2.1 Real GDP

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 2.1 Real GDP

• Real Gross Domestic Product (GDP)

– measures the output of actual goods and
services produced in an economy over a fixed
period, usually a year
– GDP per capita is a useful measure of average
living standards taking into account growth in
population

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2.1 U.S. Real GDP Per Capita, 1900-2013

Sources: Federal Reserve Bank of St. Louis, FRED Database.

http://research.stlouisfed.org/fred2/; and for data before 1960, Maddison, Angus. Historical
statistics. http://www.ggdc.net/maddison/ 1-15
2.1 Australia’s GDP, Sep 1959- Sep 2016)

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 2.1 Real GDP Per Capita
• Two key facts
1.Real GDP per capita has increased substantially
over time – between 1900 and 2013, real GDP per
capita increased by a factor of 10 – from $5000 to
$50,000
2.Real GDP per capita grows unevenly over time –
the business cycle
– US experienced 20 recessions between 1900 & 2010
– The most severe were the 1930s Depression and the
2007-09 GFC
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 2.1 Basic Business-Cycle Concepts

Business cycles are

recurrent up and
down movements in
economic activity
A recession occurs
when economic
activity declines and
real GDP per person
falls
Which is usually
longer – expansions
or recessions?
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2.2 Unemployment rate

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 2.2 Unemployment Rate

• Unemployment rate is the mirror image to

the GDP growth rate – counter-cyclical

• Why is unemployment costly?

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 2.2 Measuring Unemployment

• The unemployment rate is the percentage of total

labour force who do not have jobs and are actively
seeking jobs.
• The adult age population is divided into:
1. Employed
2. Unemployed Labor force
3. Not in the labor force
• Discouraged workers (those who would like to work but
have given up looking), and
• those who have voluntarily left the labor force

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2.2 Measuring Unemployment

 
Labour force=Number of Employed + Number of Unemployed

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2.2 Monthly unemployment rate,
the US, 1st Jan 1948-1st Jan 2017

Sources: Federal Reserve Bank of St. Louis, FRED Database.

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2.2 Monthly unemployment rate,
Australia, Jan 1989-Jan 2017

Sources: Australian Bureau of Statistics

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2.3 Inflation rate

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 2.3 Inflation

• The inflation rate tells us how rapidly the

overall level of prices is rising.
• Deflation occurs when the inflation rate is
negative.
• Hyperinflation refers to the situation of
super high inflation
• Why is inflation costly?

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 2.3 Measuring Inflation
• Price indexes are measures of the price level
• Examples:
– Consumer price index
– GDP deflator (or implicit price deflator)
Nominal GDP is the sum of the quantities of final goods produced times their
current prices.
Real GDP is constructed as the sum of the quantities of final goods times
constant prices.
100×Nominal GDP in year i
Real GDP in year i
GDP deflator of year i =

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 2.3 Inflation Rate
• The inflation rate is the % rate of change of the price level
 
over a particular period
• If the price level rises from 100 to 103, then the inflation
rate is ______
3%
• If the price level then rises from 103 to 105, then the
1.9%
inflation rate is ______

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 2.3 Australia’s Inflation Rate
(Sep 1949-Dec 2016)

Sources: Reserve Bank of Australia

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2.3 U.S. Inflation Rate, 1910-2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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3. A Closer Look at Measuring GDP:
National Income Accounting
• Gross domestic product (GDP) is the total
market value of all final goods and services
produced in an economy
– the broadest measure of economic activity
• Fundamental identity of national income
accounting:
Total production= Total Expenditure=Total Income

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3. What’s In and What’s Out of GDP

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 3. Fixed Period of Time

• We calculate GDP over a fixed period of time,

such as a quarter or a year
• GDP is a flow, which is an amount per a given
unit of time
• By contrast, a stock is a quantity at a given
point in time

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 3. Stocks Versus Flows
• A stock is an accumulation of flows
over time
• Examples:
– GDP is a flow, which accumulates into a
country’s wealth
– Budget deficit is a flow which
accumulates into public debt
– Investment is a flow which accumulates
into the capital stock

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 3. Measuring GDP:
The Expenditure Approach

• GDP is the total spending on currently

produced final goods and services in the
economy
• National income identity:
Y = C+I+G+NX
where
  Y = GDP = total production (output)
C = consumption expenditure
I = investment
G = gov’t purchases of goods & services
NX = net exports = exports - imports

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 3. Consumption Expenditure

• Total spending for currently produced

consumer goods and services
• In US, household final consumption was 68.7%
of GDP in 2012 (Australia, C = 55% of GDP)
• Basic categories:
1. Consumer durables
2. Nondurable goods
3. Services

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 3. Investment

• For economists, investment spending refers to

the purchase of physical assets, such as new
machines or new houses—purchases that add
to GDP
• Basic categories:
1. Fixed investment
2. Inventory investment
3. Residential investment

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 3. Government Purchases

• Spending by the government on currently

produced goods and services
• In US Government purchases were 15.2% of GDP
in 2012 (Australia 17.7% of GDP)
• Government consumption includes government
purchases for short-lived goods and services like
health care and police
• Government investment includes spending for
capital goods like buildings and computers
• Pure government transfers (e.g. Social Security) are
excluded from G
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 3. Net Exports

• Net exports (or trade balance) are exports

minus imports
• Why subtract imports from GDP?

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3. Shares of Expenditure Components
for Different Countries

Source: OECD and for China estimates from National Bureau of Statistics. The data are for the year 2010.
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 3. Real Versus Nominal GDP

• A nominal variable is a measure at current

market (nominal) prices (e.g., nominal GDP)
• A real variable is a measure in terms of
quantities of actual goods and services (e.g., real
GDP)
Nominal GDP
Real GDP =
Price Level

or Nominal GDP = Price Level ×Real GDP

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 4. Measuring Interest Rates

• An interest rate is the cost  of borrowing, or the

price paid for the rental of funds
• Interest rates are returns for holding debt securities,
such as bonds.
• Interest rates that receive media attention are:
– the cash rate
– housing mortgage rate

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 4. Real Versus Nominal Interest Rates
• A nominal interest rate is the percentage increase in money
 
a lender must be paid for the rental of his/her money.
• The real interest rate is the percentage increase in
purchasing power a lender must be paid for the rental of
his/her money. It takes inflation into account.
• The Fisher equation defines the real interest rate (r) as the
difference between the nominal interest rate (i) and the
expected rate of inflation (e)
r = i - e
or i = r + πe

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4. Real Versus Nominal Interest Rates
• Example: For a one-year loan with
  a 4% nominal interest rate
(i = 4%) and you expect the inflation to be 6% in a year (e =
6%), then:
r = _____________
-2%
• When the real interest rate is low, there are greater
incentives to borrow and invest, but fewer incentives to
lend.
• Why is the real interest rate a better indicator of the
incentives to borrow, invest, and lend than nominal interest
rates?

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 5. Macroeconomic Policy
• The goal of developing models is to determine what
policies can produce better macroeconomic
outcomes:
– How Can Poor Countries Get Rich?
– Is Saving Too Low?
– Do Government Budget Deficits Matter?
– How Costly Is It to Reduce Inflation?
– How Can We Make Financial Crises Less Likely?
– How Active Should Stabilization Policy Be?
– Should Macroeconomic Policy Follow Rules?
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 Summary
• What is macroeconomics about & why is it
important?
• Macroeconomics is the study of two broad topics
1. the business cycle
2. economic growth
• Macroeconomics uses economic models to explain
how the economy works
• The 3 key data sets are real GDP, the
unemployment rate & the inflation rate
• Measuring macroeconomic variables

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