Lecture 1

Introduction and Measurement Issues

What Macroeconomics Is About

Models built to explain macroeconomic phenomena.

The important phenomena are long-run growth and business cycles.
Approach is to build up macroeconomic analysis from microeconomic principles.
What Macroeconomics Is About
Long-run economic growth
Output of United States since 1869

Note decline in output in

recessions; increase in output in
some wars

sources of growth
Population growth
Increases in average labor
productivity (technology)
Investment/savings
What Macroeconomics Is About
Average labor productivity
Output produced per unit of labor input
Average labor productivity for United States since 1900

2.6% per year from 1949 to 1973

1.1% per year from 1973 to 1995
1.9% per year from 1995 to 2007
1.1% per year from 2007 to 2014
What Macroeconomics Is About
Business cycles
Business cycle: Short-run contractions and expansions in economic activity
Downward phase is called a recession

One important indicator of recession:

Unemployment
Unemployment: the number of people
who are available for work and actively
seeking work but cannot find jobs
Recessions cause unemployment rate to
rise
What Macroeconomics Is About
Macroeconomic Policy
Fiscal policy: government spending and taxation
Monetary policy: growth of money supply; determined by central bank; the Fed in
United States; Monetary Authority of Singapore.
The international economy
Open vs. closed economies
Open economy: an economy that has extensive trading and financial
relationships with other national economies
Closed economy: an economy that does not interact economically
with the rest of the world
Trade imbalances
Trade surplus: exports exceed imports
Trade deficit: imports exceed exports
Aggregation
Aggregation: summing individual economic variables to obtain economy wide totals
Distinguishes microeconomics (disaggregated) from macroeconomics (aggregated)
What Macroeconomists Do
In Touch with Data and Research: Developing and Testing an Economic Theory
State the research question
Make provisional assumptions
Work out the implications of the theory
Conduct an empirical analysis to compare the implications of the theory with the data
Evaluate the results of your comparisons

Macroeconomic Models
A macroeconomic model captures the essential features of the world needed to
analyze a particular macroeconomic problem.
Macroeconomic models should be simple, but they need not be realistic.
National Income Accounting
National income accounts: an accounting framework used in measuring
current economic activity
Three alternative approaches give the same measurements
Product approach: the amount of output produced
Income approach: the incomes generated by production
Expenditure approach: the amount of spending by purchasers
National Income Accounting
Why are the three approaches equivalent?
They must be, by definition
Any output produced (product approach) is purchased by someone (expenditure
approach) and results in income to someone (income approach)
The fundamental identity of national income accounting:

total production = total income = total expenditure

Important concept in product approach:

value added = value of output minus value of inputs purchased from other
producers
A Precise Definition of Gross Domestic Product
GDP: a measure of the market value of all newly produced final goods and services in a
country during some period of time.

All goods are measured in the same units (e.g., SGD)

yourself, the value of environmental quality, and natural resource depletion

production
Gross Domestic Product
GDP: a measure of the market value of all newly produced final goods and
services in a country during some period of time.

Only newly produced goods and services are included. If you buy a 10-year-old
baby stroller from a garage sale this year, none of the value of that stroller is
Gross Domestic Product
GDP: a measure of the market value of all newly produced final goods and
services in a country during some period of time.

A good that is an input to the production of other goods or services such as a bicycle
tire that is sold to a bicycle manufacturing company would not be included in GDP to
avoid double-counting.
Final goods & services are those that are not intermediate

used up in the same period that they are produced

Inventory investment (the amount that inventories of unsold finished goods, goods in
process, and raw materials have changed during the period) is also treated as a final
good
Gross Domestic Product
GDP: a measure of the market value of all newly produced final goods and
services in a country during some period of time.

A Mini-Cooper, purchased by you, that was made and assembled in the UK is not

Even goods produced by foreigners within SG borders are included in SG GDP.

Gross Domestic Product
GDP: a measure of the market value of all newly produced final goods and services
in a country during some period of time.

For example, if a Honda was produced in December 2018 but the car was not
sold until January 2019, then that Honda will be included in the GDP of the
period in which it was produced 2018.
Usually a year or a quarter.
Gross Domestic Product

The expenditure approach to measuring GDP

Measures total spending on final goods and services produced within a
nation during a specified period of time
Four main categories of spending: consumption (C), investment (I),
government purchases of goods and services (G), and net exports (NX)

Y = C + I + G + NX the income-expenditure identity

Gross Domestic Product
The expenditure approach to measuring GDP

1. Consumption: spending by domestic households on final

d
goods and services Not firms /businesses

About 2/3 of U.S. GDP

Three categories:
1) Consumer durables (examples: cars, TV sets, furniture, major appliances)
2) Nondurable goods (examples: food, clothing, fuel)
3) Services (examples: education, health care, financial services,
transportation)
Gross Domestic Product
The expenditure approach to measuring GDP

2. Investment: spending for new capital goods (fixed investment)

plus inventory investment
Volatile, with fixed investment about 13% to 20% of U.S. GDP
1) Business (or nonresidential) fixed investment: spending by businesses on
structures, equipment, and intellectual property products, such as software,
research and development, or artistic originals
2) Residential fixed investment: spending on the construction of houses and
apartment buildings
3)
Gross Domestic Product
The expenditure approach to measuring GDP

3. Government purchases of goods and services: spending by the

government on goods or services
About 1/5 of U.S. GDP
Not all government expenditures are purchases of goods and services
1) payments that are not made in exchange for current goods and services
Not

counted
{2) transfers, including Social Security payments, welfare, and unemployment
benefits
3) interest payments on the government debt
Gross Domestic Product
The expenditure approach to measuring GDP

4. Net exports: exports minus imports

1) Exports: goods produced in the country that are purchased by
foreigners
2) Imports: goods produced abroad that are purchased by residents
in the country
3) Imports are subtracted from GDP, as they represent goods
produced abroad, and were included in consumption, investment,
and government purchases
Expenditure Approach to Measuring GDP in the United States, 2014
Gross Domestic Product
The income approach to measuring GDP
Adds up income generated by production (including profits
and taxes paid to the government)
=compensation of employees (including benefits)
+ profits
+ government taxes
+ other income
Gross Domestic Product
Must be Singaporean citizen

GNP vs. GDP 9

GNP (gross national product) = output produced by domestically owned

factors of production
GDP = output produced within a nation
GDP = GNP NFP
NFP = net factor payments from abroad
= payments to domestically owned factors located abroad minus payments to
foreign factors located domestically
Gross Domestic Product
National Income Accounting Example
Fictional Island Economy •
Éñ
9
.

Coconut Producer, Restaurant, Consumers, Government -

Total
profits of
24 m
firms

hm&↳←
Consume 8m of coconuts
→ ☒^ * •
GDP Using the Product Approach

=
revenue

= pwttf

=
wages
GDP Using the Income Approach

GDP Using the Income Approach

After-tax wage income $13.5 million
t Interest $0.5 million
After-tax profits $24million
Taxes tax revenue $5.5 million
GDP $43.5 million
GDP Using the Expenditure Approach
Problems in Measuring GDP

Economic activity in the underground economy cannot be measured

directly this activity might be measured indirectly by accounting for the
use of currency.

Government production is difficult to measure, as the output (for example

defense services) is typically not sold in the market.
Real GDP, Price Indexes, and Inflation
GDP not
to attribute change in to 0 in
qty price
Real GDP →
,

Nominal variables are those in dollar terms

Problem: Do changes in nominal values reflect changes in prices or
quantities?
Real variables: adjust for price changes; reflect only quantity
changes
Real GDP, Price Indexes, and Inflation
Real GDP, Price Indexes, and Inflation
Real GDP, Price Indexes, and Inflation
Price Indexes
A price index measures the average level of prices for some specified set of goods and
services, relative to the prices in a specified base year
GDP deflator = 100 × nominal GDP/real GDP
Note that base year P = 100

Consumer Price Index (CPI)

Monthly index of consumer prices; index averages 100 in reference base period
Based on basket of goods in expenditure base period (updated periodically)
Real GDP, Price Indexes, and Inflation
Inflation
Calculate inflation rate:
t+1 = (Pt+1 Pt)/Pt = Pt+1/Pt

The inflation rate in the United

States, 1960 2014
Real GDP, Price Indexes, and Inflation
Problems in Measuring Real GDP and the Price Level

The relative prices of goods change over time. Price indexes with fixed

becomes relatively cheaper than another

This problem is known as substitution bias

The quality of goods and services changes over time.

New goods and services are introduced, and some goods and services
become obsolete.
Takeaway

GDP with three approaches

Nominal vs real GDP
Price index and inflation
 producer consumers Exposes
1) coal producer
steel
2m tuns
91J 10m tons qty
8m tuns qty
qty 15m tons

price $20 / ton

Prue $5 / ton
lot of Wal
15×5> $75m
wages $50M (domestic

profit $25m Cost of coal

w ✗ F- $50m
cimpurds)

wages $40m
profit $35m

]
i Product approach :

GDP =
15×5 1- (20×10-75-50)

2$ 150 million

Ii ) Expenditure approach
:

GDP = Ct It G- +NX

= 8×20101-0 1- (2×20-10×5)

z 160 -10

150 million

iii) Znwme approach :

GDP =
So -140 + (251-35)
☒ 150 million