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Macroeconomics: full summary final exam year 1
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summary for final exam macroeconomics year 1. UvA
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Summary(short) macro readings Makes use of data that history provides them with
Real gdp is adjusted for inflation, nominal is not.
When inflation rate above zero, prices are rising. When its below zero, prices are falling. If
inflation rate declines but remains positive prices are rising but at slow rate
Endogenous: variables that model tries to explain. Exogenous: taking as given
Purpose model: show how exogenous variables affect endogenous variables
No single model can answer all questions. Use different models to explain different
economic phenomena.
For market to clear continuously, prices must adjust instantly to changes in supply and
demand. Many wages and prices adjust slowly.
According to most macroeconomists, models with flexible prices describe economy in long
run, whereas models with sticky prices offer better description of economy in short run.
Microeconomies is study of how firms and individuals make decisions and how these
decision makers interact. Because macroeconomic events arise from many microeconomic
interactions, all macroeconomic models must be consistent with microeconomic
foundations, even if those foundations are only implicit.
GDP: nation’s total income and expenditure on its output of goods/services
CPI measures level of prices
GDP considered best measure of how well economy is performing (every 3 months)
How can GDP measure both economy’s income & expenditure on output?
1. Are the same. For economy as a whole, income must equal expenditures
2. Every transaction has buyer and seller. When income = 1000, expenditure = 1000, this
contributes 1000 to GDP (not 2000).
National income accounting: system used to measure GDP and many related stats.
More precise def: GDP is the market value of all final goods/services produced within an
economy in given period of time.
Rules economists follow in constructing GDP:
1. Adding apples and oranges (diversity complicates calc due to different values, use market
prices)
2. Used goods (GDP measures value of currently produced goods and services. Sale of used
Renault reflects transfer of asset, not addition to economy’s income. Sale of used good not
included as part of GDP)
3. Treatment of inventories
o If you fail to sell, how does this affect GDP?
Depends on what happens to unsold product.
1. Bread can go stale and cannot be sold: paid more in wages but not receive any
additional revenue, so firms profit reduced. Total expenditure not changed
because no one buys the bread. Total income not changed, more is distributed
as wages and less as profit. Transaction does not affect expenditure nor income,
it does not alter GDP.
2. Suppose, instead, that bread (which, because of secret additive, has long shelf
life) is out into inventory to be sold later. In this case transaction treated
differently. Owners of firm assumed to have ‘purchased’ the bread for the firm’s
inventory, and firm’s profit is not reduced by additional wages it has paid.
Because the higher wages raise total income, and greater spending on inventory
raises total expenditures, the GDP rises.
, o What happens if selling bread out of inventory?
1. Much like sale used good, there is spending by bread consumers, but there is
inventory disinvestment by firm. This negative spending by firm offsets the
positive spending by consumers, so
The sale out of inventory does not affect GDP.
2. General rule: when firm increases its inventory of goods, this investment in
inventory is counted as an expenditure by the firm’s owners. Thus, production
for inventory increases GDP just as much as production for final sale. sale out of
inventory, is combination of positive spending (purchase) and negative spending
(inventory disinvestment), so it does not influence GDP, this treatment of
inventories ensures that GDP reflects the economy’s current production of
goods and services
4 Intermediate goods and value added
o GDP includes only value of final goods. Reason: value intermediate goods is already
included as part of market price of final goods in which they are used.
o GDP is total value of final goods and services produced
o For economy as a whole, sum of all value added must equal value of all final goods
and services. GDP is also total value added of all firms in the economy
o To return to example of the Frenchman and his Renault, what if he sells his car for
€25,000 to used car dealer, who then sells it to someone else for €35,000? Is that
part of GDP? Answer is that only value that has been added to the car by dealer is
part of GDP, in this case €10,000. It represents value of the service the used car
dealer has provided in buying the car and finding
purchaser for it.
5 Housing services and other imputations
o Sold goods not sold in marketplace and therefore do not have market prices
o Imputed value: if GDP is to include the value of these goods and services, we must
use an estimate of their value.
1. Imputations important for determining value of housing. Rent part of GDP
2. Imputations also arise in valuing gov. services. Giving value to hese eservices
difficult because not sold in marketplace and does not have market price. Wages
are used as measure
3. Gdp includes imputed rent on owner-occupied houses, (not: imputed rent on
car, lawnmower, jewelry and other durable goods owned by households). Value
of these rental services left out of GDP. Some of output of economy
produced/consumed at home and never enters marketplace (homecooked meal
similar to meals at restaurants, yet value added in meals at home is left out of
GDP).
4. No imputation made for value of goods/services sold in black economy. To
evade taxation or illegal activity (ex: paid in cash and under reporting earnings,
gardeners paid off books, illegal drug trade). Not included, economists attempt
to measure it.
GDP imperfect measure of economic activity
Real GDP: value of goods/services measured using a constant set of prices. That is, real GDP
shows what would have happened to expenditure on output if quantities had changed but
prices had not.
Real GDP provides better measure of economic well-being than nominal GDP
GDP deflator (implicit price deflator): nominal gdp/real gdp. Reflects what is happening to
the overall level of prices in the economy
, Nominal GDP measures current money value of output of economy. Real GDP measures
output valued at constant prices. GDP deflator measures price of output relative to its price
in base year. Real GDP = Nominal GDP / GDP deflator
Dividing GDP into 3 categroies of spending:
1. Final consumption expenditure
- For own same, with aim of consuming
- Household consumption divided: Non-durable goods (short time), durable goods (long
time), semi-durable goods (less than durable), services (work done for consumers by
indiv/firms)
- Non-profit isntututions servings households similar to households by not aiming for
profit (ex: universities, churches, charities)
- General gov. consumption includes spending by local and central gov. on goods/services
such as items military equipment. Does not include transfer payments to individuals,
because transfer payments reallocate existing income are are not made in exchange for
goods/services.
- Net tourist consumption: amount consumption foreign tourist – amount consumption
domestic residents when going on holiday (better classified as part of net exports from
macroeconomist point of view)
2. Gross capital formation: way of saving total investment . two subcategegories:
1. Gross fixed capital formation:
Business fixed investment (new equipment)
general government fixed investment (schools/motorways)
residential fixed investment (housing)
2. Inventory investment: increase in firms’ inventories of goods (if falling, inventory
investment is negative)
3. Net exports: export – import
Positive when value export is greater than value import, vice versa
We can define macro-economist’s four categories of expenditure as:
1. Consumption (C)
2. Investment (I)
3. Government purchases (G)
4. Net exports (NX)
Thus: Y(total gdp) = C + I + G + NX
(an equation that must hold because of the way the variables are defined) and is therefore
called the national income accounts identity
Other measures of income:
GNP = GDP + factor payments from abroad – factor payments to abroad
GNP measures total income earned by nationals
NNP = GNP – Depreciation
GDP remains most widely used measure of economic activity
Formula CPI:
Most closely watched index of prices, but not only such index. Another is producer price index,
which measures price of typical basket of goods bought by firms rather than consumers.
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