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Summary Macro
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- Katholieke Universiteit Leuven (KU Leuven)
This document provides a summary of "Macro" in the course "Macro & International Economics".
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Chapter 1: What is (Macro)economics?Microeconomics and macroeconomics
- Microeconomics focuses on the individual parts of the economy. How households and firms make
decisions and how they interact in specific markets.
- Macroeconomics looks at the economy as a whole. Economy-wide phenomena, including inflation,
unemployment, and economic growth.
Three principles of macroeconomics
- The standard of living depends on a country’s ability to produce goods and services.
- Prices rise when the government prints too much money.
- Society faces a short-run trade-off between inflation and unemployment.
Principle 1: An Economy’s Standard of Living is Related to its Ability to Produce Goods and Services
- Standard of living - a measure of welfare based on the amount of goods and services a person’s
income can buy.
- Almost all variations in living standards are explained by differences in countries’ productivities.
- Productivity is the amount of goods and services produced from each hour of a worker’s time.
Principle 2: Prices Rise When the Government Prints Too Much Money
- Inflation is an increase in the overall level of prices in the economy.
- One cause of inflation is the growth in the quantity of money.
- When the government creates large quantities of money, the value of the money falls.
Principle 3: Society Faces a Short-run trade-off Between Inflation and Unemployment.
The Phillips Curve illustrates the trade-off between inflation and unemployment:
↑ Inflation Unemployment It’s a short-run trade-off!
Chapter 2: Thinking like a (macro)economist
- Economists use models to simplify reality in order to improve our understanding of the world.
- Endogenous variables: values are determined within the model.
- Exogenous variables: values are determined outside the model.
- Ceteris paribus meaning ‘other things equal’, is used to note when other factors that might affect
outcomes are assumed to be constant.
Role of assumptions
- Sometimes it is useful simplifying the real world.
o Example: to understand international trade, it may be helpful to start out assuming that there are
only two countries in the world producing only two goods.
o Economists need to think about which assumptions are most helpful to make.
o Once we understand the model, we can begin to relax some assumptions.
- The art in scientific thinking is deciding which assumptions to make.
o Economists use different assumptions to answer different questions.
(Macro)economist as Policy Advisor
When economists are trying to explain the world, they are scientists. When economists are trying to
change the world, they are policy advisors.
Positive statements are statements that attempt to describe the world as it is. Example: Higher
federal budget deficits will cause interest rates to increase.
Normative statements are statements about how the world should be. Example: The income gains
from a higher minimum wage are worth more than any slight reductions in employment.
, Chapter 4: Measuring a nation’s well-being and
the price level
The economy’s income and expenditure
- When judging whether the economy is doing well or poorly, it is natural to look at the total income
that everyone in the economy is earning. Given that the income determines how much we spend.
- For an economy as a whole, income must equal expenditure because:
o Every transaction has a buyer and a seller.
o Every dollar of spending by some buyer is a dollar of income for some seller.
Circular Flow
Simplified version Extended version
The Circular Flow diagram simplifies the This is extended which takes into consideration
economy in the following way: summaries the that households do not only spend their income
markets into two markets (goods and services & on buying goods and services. That they also
factors of production) and the number of actors have to pay taxes to government or are saving
is summaries as well (Firms & Households). into financial institutions.
How to read it? Let’s start with the Firms. They As for the market of goods and services, it also
produce goods/services and sell them on the considers that government will buy part of this
market. These are then bought by the market. As for the households, not everyone
households which is the revenue for the firms. buys from the local market, so we have to take
(Markets for goods and services) into consideration the foreign exchange market.
For firms to be able to produce, they have to For the market for factors of production, they
have factors of production which they give borrow money from the financial institutions
wages, rent and profit in. That results in income which is the money how they will buy on the
for the households. The households bring markets for factors of production.
labour, land and capital to the factors of
production for the firms. (Markets for factors of
productions)
Measurement of Gross Domestic Product
- Gross domestic product (GDP) is a measure of the income and expenditures of an economy.
- GDP = It is the market value of all final goods and services produced within a country in each period
of time.
• “GDP is the Market Value . . .” Output is valued at market prices.
• “. . . Of All . . .” Not fully correct: excludes informal & household production, illegal market, …
• “. . . Final . . .” It records only the value of final goods, not intermediate goods (the value is
counted only once).
, • “. . . Goods and Services . . . “ It includes both tangible goods (food, clothing, cars) and
intangible services (haircuts, house cleaning, doctor visits).
• “. . . Produced . . .” It includes goods and services produced in the period we are considering,
not transactions involving goods produced in the past.
(Second-hand not included. Example: Because you have sold your car on the second-hand market.
The other person has sold that car to the third person, as this third person sells it back to me. This
results in me still having the same car. It would not make sense to add this car to the GDP each
time because we will just simply inflate our living standards.)
• “. . . Within a Country . . .” It measures the value of production within the geographic confines
of a country.
• “. . . In a Given Period of Time.” It measures the value of production that takes place within a
specific interval of time, usually a year or a quarter (three months).
Components of GDP
GDP (Y) is the sum of the following: Y = C + I + G + NX
- Consumption (C): The spending by households on finished goods and services, except for purchases
of new housing.
- Investment (I): Spending on goods that will be used in the future to produce other goods and
services = capital equipment + inventories + structures (including new housing).
- Government Purchases (G): The spending on goods and services by local and central governments.
Does not include transfer payments because they are not made in exchange for currently produced
goods or services. They are not included because they do not directly add value to the GDP. (What
are transfer payments? For example, all kind of benefits that are paid by government in concept of
public social security (employment benefits, subsidies, …).)
- Net Exports (NX): = export – import. Import is already included in C, I and G. Part of the production of
geographic confines will not be consumed within these boarders.
Accounting equation but not a production function/behavior equation!
If we look at the table, it shows the total GDP for the UK
economy in 2009 and the breakdown of GDP among its four
components. As we look at the numbers, consumption is the
largest factor with 65% of the GDP. The second largest factor
is government purchases with 23%, last but not least is
investments with 14%. Net exports are -2% which means that
overall that the value of the imports exceeds the value of
exports.
Other measures of Income
- Gross National Product (GNP) is the total market value of all final goods and services produced by
the residents of a country in a given period of time. (Value of production that people contribute from
one country to another. Example: Someone lives in Antwerp but works in Brada which means that
value added creating by production will be added to the Dutch GDP and not the Belgian GDP. His
contribution will be added to the Belgian GNP since his residence is in Belgium, not the Netherlands.)
- Net National Product (NNP): GNP minus depreciations.
Real GDP vs Nominal GDP
- Nominal GDP values the production of goods and services at current prices.
- Real GDP values the production of goods and services at constant prices.
- An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator. If
we don’t, it can be a danger to the fact that it will not represent the change in living standards but
simply the change in prices.
, Example real GDP & nominal GDP
If we look at the overview, we can see
the prices that hamburgers and hotdogs
were sold at during 3 following years
(2009, 2010 and 2011).
Nominal GDP: We take the price of the
market x the quantity sold of the
product.
Real GDP: We take a base year and take
the price of this year x the quantity sold.
This allows us to see that the GDP is
not rising soly due to the raise in
prices but the change in quantity.
GDP Deflator
- The GDP deflator is a measure of the price level calculated as follows:
- It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the
quantities produced.
- Nominal GDP = Real GDP * GDP deflator / 100
Limitations of GDP as a measure of well-being
- Most economists consider GDP to be the most appropriate measure of the economic well-being of a
society. Means reason of this: GDP per person tells us the mean income and expenditure of the
people in the economy.
- Higher GDP per person indicates a higher standard of living.
- GDP is not a perfect measure of the happiness or quality of life, however!
GDP and Economic well-being
Some things that contribute to well-being are not included in GDP.
- The value of leisure. Example: If you have the choice between leisure time and work, you will choose
which will contribute the most to your own values. However, if you are forced to work more hours,
the consequence is that your utility will go down and your own well being will go down aswell. As the
consequences for GDP, this will go up.
- The value of a clean environment. Example: Production of service/goods does not always have a
good impact on the environment while it increases the GDP.
- The value of almost all activity that takes place outside of markets, such as the value of the time
parents spend with their children and the value of volunteer work.
GDP has nothing to say about the distribution of income.
Measuring the cost of living
- Inflation is the term used to describe a situation in which the economy’s overall price level is rising.
- The inflation rate is the percentage change in the price level from the previous period.
Consumer Price Index (measurement for the cost of living)
- The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a
typical consumer.
- Statistical offices (each country has their own) report the CPI each month.
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