Summary Macroeconomics a European Perspective - Macroeconomics (ECB1MACR)
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Macroeconomics (ECB1MACR)
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University College Utrecht (UCU)
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Macroeconomics
A summary of the book "Macroeconomics a European perspective" that is discussed in the subject Macroeconomics. Chapters 1-9 and 11-17. Also the CORE units 10, 16 and 17 are inclusive.
Summary Macroeconomics a European Perspective, ISBN: 9780273728009 Macroeconomics Course incl. other book chapter
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Macroeconomics
Chapter 1
1.1 Europe and the euro
The Europe Union, or EU27 are 27 countries which form a common market- an economic zone where
people and goods could move freely. When macroeconomics study an economy, they first look at
three variables:
- Output; the level of production of the economy as a whole- and its rate of growth.
- The unemployment rate; the proportion of workers in the economy who are not employed
and are looking for a job.
- The inflation rate; the rate at which the average price of the goods in the economy is
increasing over time.
Macroeconomics is concerned about three main issues that have been at the heart of the economic
debate for a long time:
1. High unemployment Ch.7
2. The growth of income per person (or per capita) Ch.11
3. The euro
1.2 The economic outlook in the USA
There are four reasons for the recent slowdown of the grow of the economy in the US:
1. The oil prices
2. A fall in the house prices
3. A fall in the stock market
4. A restriction of credit
1.3 BRIC countries
Brazil, China, India, and Russia (the BRICs) have grown rapidly over the past decade and are now the
largest economies outside of the group of advanced countries. Especially China’s economy is growing
very fast. The unemployment rate is very hard to measure in poorer countries because many workers
may decide to stay in agriculture rather than be unemployed, as a result official unemployment rates
are typically not very informative.
The incredible growth of China comes from two sources. The first is very high accumulation of capital.
The investment rate in China is between 40-45% of output. For comparison, in the USA it is only 17%.
More capital means higher productivity and higher output. The second is very fast technological
progress.
Chapter 2
2.1 aggregate output
Aggregate is the word that macroeconomists use for total. It was not until the end of the Second
World War that the System of National Accounts (SNA) was put together in most European
countries.
GDP: production and income
The measure of aggregate output in the national income accounts is called the gross domestic
product (GDP). An intermediate good is a good that is used up in the production of final goods.
, 1. GDP is the value of the FINAL goods and services produced in the economy during a given
period.
We want to count only the production of final goods, not intermediate goods. We do not
want our measure of aggregate output to depend on whether firms decide to merge. This is
one way to construct GDP: by recording and adding up the production of all final goods, this
is indeed roughly the way actual GDP numbers are put together.
2. GDP is the sum of value added in the economy during a given period.
The term value added is defined as the value of the production minus the value of the
intermediate goods used in production.
The value of final goods and services can also be thought of as the sum of the value added by all the
firms in the economy. These two points were in perspective of the production side. The other way of
looking at GDP is from the income side. Some of the revenue a firm makes goes to the workers, this
component is called labour income. The rest goes to the firm, which is called capital income or profit
income.
3. GDP is the sum of incomes in the economy during a given period.
The revenue paid to the government in the form of sales taxes is called indirect taxes.
Nominal and real GDP
Nominal GDP is the sum of the quantities of final goods produced multiplied by their current prices.
This is also called GDP at current prices. The nominal GDP increases over time for two reasons:
- The production of most goods increases over time.
- The prices of most goods also increase over time.
Real GDP is constructed as the sum of the production of final goods multiplied by constant (rather
than current) prices. This is also called GDP in terms of goods, GDP at constant prices or GDP
adjusted for inflation.
To construct real GDP, we need to multiply the number of goods in each year by common price, for
example if you use prices from the year 2000, this approach will give the real GDP in 2000 prices. The
year 2000 is in this case the base year. The problem of constructing real GDP in practice is that there
is obviously more than one final good. The real GDP must be defined as a weighted average of the
output of all final goods, and this brings us to what the weights should be.
The relative prices of the goods would appear to be the natural weights. If one good cost twice as
much per unit as another, then that good should count for twice as much as the other in the
construction of real output.
Given:
- In following chapters, GDP will refer to real GDP, Y t will denote real GDP in year t.
- Nominal GDP and variable measured in current prices will be denoted by euro sign in front of
them; €Y t for nominal GDP in year t.
€ Y (nominal GDP)
The GDP deflator is defined as the ratio of nominal to real GDP: P=
Y (real GDP)
In the base year, the real GDP is equal to the nominal GDP.
The GDP deflator inflation is a measure of the increase in the price level of the goods produced in the
economy during a given year, Y t :
π=growth rte of nominal GDP−growth rate of real GDP
€ Y t −€ Y t−1 Y t−Y t−1
¿ −
€ Y t −1 Y t−1
,GDP: level versus growth rate
The real GDP per capita, is the ratio of real GDP to the population of the country. It gives as the
average standard of living of the country.
In assessing the performance of the economy from year to year, economists focus, however, on the
rate of growth of real GDP, called the GDP growth.
- Periods of positive GDP growth are called expansions.
- Periods of negative GDP growth are called recessions.
2.2 The other major macroeconomic variables
The variables unemployment and inflation, tell us about important aspects of how an economy is
performing.
The unemployment rate
Employment is the number of people who have a job. Unemployment is the number of people who
do not have a job but are looking for one. The labour force is the sum of employment and
unemployment.
Labour force=Employment +Unemployment
L=N +U
The unemployment rate (u) is the ratio of the number of people who are unemployed to the number
U
of people in the labour force: u=
L
To be classified as unemployed, a person must meet two conditions: he or she does not have a job,
and he or she is looking for one. This second one is harder to assess.
Today, most countries rely on large surveys of households to compute the unemployment rate. In
Europe, this survey is called the Labour Force Survey (LFS).
Note that only people who are looking for a job are counted as unemployed; those who do not have a
job and are not looking for one are counted as not in the labour force. When unemployment is high,
some of the unemployed give up looking for a job and therefore are no longer counted as
unemployed. These people are known as discouraged workers.
A higher unemployment rate is typically associated with a lower participation rate, defined as the
ratio of the labour force to the total population of working age.
Why do economists care about unemployment?
Economists care about unemployment for two reasons.
1. Its direct effects on the welfare of the unemployed.
Unemployment is often associated with financial and psychological suffering. How much
suffering depend on the nature of the unemployment. One image of unemployment is that of
a stagnant pool, of people remaining unemployed for long periods of time.
2. It provides a signal that the economy may not be using some of its resources efficiently.
Many workers who want to work do not find jobs; the economy is not efficiently utilizing its
human resources. So, a very low unemployment can be a problem, an economy in which
unemployment is very low may be over-utilizing its human resources and may run into labour
shortages.
The inflation rate
Inflation is a sustained rise in the general level of prices, the price level. The inflation rate is the rate
at which the price level increases. Symmetrically, deflation is a sustained decline in the price level. It
corresponds to a negative inflation rate.
, The GDP deflator
If we see nominal GDP increasing faster than real GDP, the difference must come from an increase in
prices. The GDP deflator in year t , Pt , is defined as the ratio of nominal GDP to real GDP in t :
Nominal GD P t € Y t
Pt = =
Real GD Pt Yt
In the year in which, by construction, real GDP is equal to nominal GDP. The GDP deflator is what is
called an index number.
Nominal GDP is equal to the GDP deflator multiplied by real GDP.
The consumer price index
The GDP deflator gives the average price of output -the final goods produced in the economy- but
consumers care about the average price of consumption -the goods they consume-. The two prices
need to be the same: the set of goods produced in the economy is not the same as the set of goods
purchased by consumer, for two reasons:
- Some of the goods in GDP are sold not to consumers but to firms, the government, or the
foreigners.
- Some of the goods bought by consumers are not produced domestically but re imported
from abroad.
To measure the average price of consumption, or equivalently, the cost of living, macroeconomists
look at another index, the consumer price index (CPI). In Europa, the price index which is most
frequently used is the harmonized index of consumer prices (HICP), measured by Eurostat, the
Statistical Office of the European Communities. The CPI and HICP are also indexes. It is set to 100 in
the period chosen as the base period.
The HCIP and the GDP deflator move together most of the time, but there are exceptions. When the
increase in the HCIP was slightly smaller, the price of goods consumed in the euro area (measured by
HICP) was lower than the price of goods produced in the euro area (measured by the GDP deflator).
In what follows, we shall typically assume that the two indexes move together, so we do not need to
distinguish between them. We shall simply talk about the price level and denote it by Pt , without
indication whether we have the CPI or the GDP deflator in mind.
Why de economists care about inflation?
If a higher inflation rate meant just a faster but proportional increase in all prices and wages –a case
called pure inflation- inflation would be only a minor inconvenience for consumers, as relative prices
would be unaffected. But this does not exist.
During periods of inflation, not all prices and wages rise proportionately. Consequently, inflation
affects income distribution, meaning for insta that retirees in many countries receive payments that
do not keep up with the price level, so they lose in relation to other groups when inflation is high.
Inflation leads to other distortions. Variations in relative prices also lead to more uncertainty, making
it harder for firms to make decisions about the future, such as investment decisions. Taxation
interacts with inflation to create more distortions. If tax brackets are not adjusted for inflation, for
example, people move into higher and higher tax brackets as their nominal income increases, even if
their real income remains the same.
But deflation would create the same problems as high inflation. So according to most
macroeconomists the best rate of inflation is a low and stable rate of inflation, between 0 to 3%.
2.3 The short run, the medium run, and the long run
What determines the level of aggregate output in an economy?
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