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Summary: Introduction to macroeconomics
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- Vrije Universiteit Brussel (VUB)
Summary: Introduction to macroeconomics
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Introduction tomacroeconomics : summary
Chapter 1: What is economics?
1) Microeconomics and macroeconomics
> Microeconomics: It is the study of how households and rms make decisions and how they
interact in markets.
> Macroeconomics: It is the study of economy-wide phenomena, including in ation,
unemployment and economic growth.
Microeconomics and macroeconomics are closely intertwined. Because changes in the overall
economy arise from the decisions of millions of individuals, it is impossible to understand
macroeconomic developments without considering the associated microeconomic decisions. For
example: A micro-economist might study the e ect of a cut in income tax on the overall
production of goods and services in an economy. To analyse the issue, they must consider how
the tax cut a ects the decisions of households concerning how much to spend on goods and
services.
2) Measuring an economy’s income
2.1 AN ECONOMY’S STANDARD OF LIVING IS RELATED TO ITS ABILITY TO PRODUCE GOODS AND
SERVICES.
A key concept in macroeconomics is economic growth and it is usually expressed over a
quartered annually.
> Economic growth: It is the amount of goods and services in an economy over a period of time.
One measure of the economic well-being of a nation is given by gross domestic product per
capita of the population, which can be seen as being the average income per head of the
population. If you look at GDP per capita gures, it becomes clear that many advanced
economies have a relatively high income per capita, whereas in countries in sub-Saharan Africa,
average incomes are much lower and, in some cases, signi cantly lower.
> Gross domestic product: It is the market value of all goods and services produced within a
country in a given period of time divided by the population of a country to give a per capita gure.
Gross domestic product (GDP)
is the market value of all
nal goods and services
produced
within a country
in a given periods of time.
Market value refers to the fact that goods and services traded in informal sector are not included.
Produced refers to the fact that sales of used goods are not included.
Within a country is about knowing where the products are created. Is it domestically? If it is the
case where it is produced? If not, by whom is it produced?
Period of time can di er from quarters (Q1, Q2, Q3, Q4) to years.
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, Not surprisingly, the large variation in average income between di erent worldwide countries is
re ected in various other measures of the quality of life and standard of living. Citizens of high-
income countries typically have better nutrition, better health care and longer life expectancy than
citizens of low-income countries, as well as more TV sets, more gadgets and more cars.
> Standard of living: It refers to the amount of goods and services that can be purchased by the
population of a country. Usually measured by the in ation-adjusted (real) income per head of the
population.
Variation in living standards is attributable to di erences in countries’ productivity. In nations
where workers can produce a large quantity of goods and services per unit of time, many people
enjoy a high standard of living. In nations where workers are less productive, people endure a
more meagre existence. Similarly, the growth rate of a nation’s productivity determines the growth
rate of its average income.
> Productivity: It is the quantity of goods and services produced from each hour of a worker or
factor of production’s time.
The relationship between productivity and living standards also has profound implications for
public policy. When thinking about how any policy will a ect living standards, the key question is
how it will a ect our ability to produce goods and services. To boost living standards,
policymakers need to raise productivity by ensuring that workers are well educated, have the
tools and infrastructure needed to produce goods and services, and have access to the best
available technology.
However, the standard of living is not the only measure of well-being.
2.2 PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY
This is tied to the phenomenon of in ation. High in ation is a problem because it imposes serious
costs on society. Keeping in ation at a low level is a goal of economic policymakers around the
world. In almost all cases of high or persistent in ation, a causal factor is the growth in the
quantity of money. When a government creates large quantities of the nation’s money, without any
corresponding increase in output or productivity, the value of the money falls. It is generally
accepted that there is a relationship between the growth in the quantity of money and the rate of
growth of prices.
> In ation: It is an increase in the overall level of prices in the economy.
Chapter 2: Thinking like an economist
1) Economic methodology
1.1 MODELS
1. Use of the model
Economics use a lot of models. A model is a representation of reality which facilitates
understanding of how something works. Models can be used as a means of helping understand
the real world and for making informed decisions and judgements. They are most often composed
of diagrams and equations. By feeding in data, economists can use models to generate outcomes
which provide some insight and form the basis of decision-making.
Economists use models to represent the world around them. We use models to represent how
markets work, how the economy as a whole works, how consumers behave and how rms
behave. These models are based on assumptions, some of which might not be fully accurate as a
representation of how the real world works or how the economic agents which form part of the
model behave. This does not necessarily detract from the value of the model in describing how
the phenomenon under investigation works.
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, Economics models have two principals uses:
1. One is for predicting and forecasting what might happen in the future as a consequence of a
decision or policy.
2. The other is to stimulate an event and provide a comparison with what would have happened
if the decision, policy or change had not happened. It refers to the counterfactual.
> Counterfactual: It is the analysis which is based on a premise of what would have occurred if
something had not happened.
Models are valuable in that they allow economists to manipulate variables which form part of the
model and explore what might happen. Economics models will always contain a number of
variables. Some of these variables are determined by the model and some are generated within
the model.
For example: Take the market model where the quantity demanded (Qd) is dependent on the price
(P). Qd is said to be the dependent variable. Its value will be dependent on the functional
relationship in the model (the factors that a ect demand) such as incomes, tastes and the price of
other goods. Qd can be described as an endogenous variable. Price on the other hand, is the
independent variable. It a ects the model (the quantity demanded) but is not a ected by it. The
price is not determined by, or dependent on, the quantity demanded. Price would be referred to
as an exogenous variable.
> Endogenous variable: It is a variable whose value is determined within the model.
> Exogenous variable: It is a variable whose value is determined outside the model.
Models are inherently unstable the longer the time period being considered and forecast. Shocks
occur which are impossible to factor into the building of models. These not only have short-term
impacts but may also change longer-term dynamics.
2. Cause and e ect
One problem facing economists is separating out cause and e ect. Observation and experience
can lead to the identi cation of phenomena occurring which intuition would seem to suggest are
related in some way.
For example: Does a change in price cause a change in the amount bought by consumers, or
does quantity bought a ect price?
Economists will utilise ceteris paribus to note when other factors that might a ect outcomes are
assumed to be constant. This method leads to an answer but, how do we know if it is correct?
> Ceteris paribus: It stands for “other things equal”. It is a term used to describe analysis where
one variable in the model is allowed to vary while others are held constant.
3. Human values in models
It refers to the consideration of values in a model, the signi cances of the a ect of an action or a
policy that might be subject to disagreements as well as the value of the associated costs and
bene ts.
Models also allow inferences to be made. This means that conclusions, consequences or
explanations can be drawn based on the evidence provided by the model. This is not to say that
these conclusions are full and nal. They are simply what may be reasonably and logically derived
based on the manipulations of the model.
> Inferences: It is a conclusion or an explanation derived from evidence and reasoning.
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, For example: Models of climate change may suggest that the increase in human-generated
carbon emissions will contribute to a change in the global climate. There may be some who would
disagree with this basic conclusion, partly because they dispute the “facts” which form the basic
of the model.
4. Manipulating models
Economists will often use models based on mathematical formulae. This can allow the modeller
the ability to manipulate the numbers in the formula and identify the extent to which outcomes
di er. When a model is manipulated, outcomes can be identi ed. The model may help to explain
the mechanism or reasons why the outcomes identi ed occur. The outcomes from models can
then be compared to actual data to see the extent to which the model is useful in explaining
observed data and behaviour.
The explanatory power of models is dependent on how well they are built. If they are too
simpli ed or the assumptions cannot be reasonably observed in the real world, then their
explanatory power breaks down.
1.2 TYPES OF REASONING
Science discovers new knowledge is through asking questions. When questions are asked, there
are di erent routes which scientists take to explore those questions or, in some cases, arrive at
the questions themselves. We can identify di erent types of reasoning which help clarify the
process involved. There is no ‘right’ way of reasoning, but there is debate about which produces
more reliable theories, which in turn have predictive power.
1. Deductive reasoning
Deductive reasoning begins with known ‘facts’ and ‘truths’, things that we know to be true. It
then, works through a process of using these facts or truths to arrive at answers to the question
we are interested in and, as a consequence, arriving at new facts or truths.
The question might take the form of a general statement/hypothesis. To discover whether the
hypothesis is true, it must be tested. If the facts are applied to the hypothesis, then the
conclusions drawn allow us to discover whether the hypothesis is true.
> Hypothesis: It is an assumption, a tentative prediction, an explanation or supposition for
something.
2. Inductive reasoning
Inductive reasoning begins with data and observations. The data or observations are analysed.
From this analysis, patterns are identi ed, which may be patterns of behaviour. These patterns
generate a question, or hypothesis, which explains the observed behaviour or pattern. This
explanation or conclusion is then applied to all other instances of the phenomena. This is o ered
to as ‘generalisation’. In generalising, the researcher is o ering a theory or explanation of events
and phenomena. This theory can then be tested and veri ed, or could be shown to be inaccurate
and amended, or a new theory proposed to replace the incorrect one.
> Generalisation: It is the act of formulating general concepts or explanations by inferring from
speci c instances of an event or behaviour.
If there was only one instance of a certain ‘pattern’, it may be that the researcher could not
generalise to all instances, but if the pattern was observed and veri ed by the data in a number of
instances, it may be possible to arrive at a general theory. Identifying patterns in data means that
the data must be collected, be available for study and be reliably complete. This is not always
possible.
For example: Looking at the GDP for di erent countries online, often highlights di erences in
results from one source to another. This may be explained by the way in which the data is
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