Lesson 3

The Macroeconomic Perspective

• Macroeconomics focuses on the economy as a whole (or on whole economies as they

interact)
• Macroeconomic externality - occurs when what happens at the macro level is different
from and inferior to what happens at the micro level. The economy as a whole is
massive.
• Economic indicators - statistics that measure one or more aspects of the macro
economic
• Measures of aggregate production, like GDP
• Measures of employment and unemployment, and measures of inflation, like the
percent change in the Consumer Price Index
• Misery Index - the sum of the inflation and unemployment rates as a measure of how
bad (i.e., miserable) the economy is.

Macroeconomic Goals, Framework, and Policies

Goals

In thinking about the overall health of the macroeconomy, it is useful to consider three primary
goals: economic growth, full employment (or low unemployment), and stable prices (or low
inflation):

• Economic growth ultimately determines the prevailing standard of living in a country.

• Unemployment, as measured by the unemployment rate, is the percentage of people in
the labor force who do not have a job.
• Inflation is a sustained increase in the overall level of prices.
Frameworks

• Economists use theories and models to explain and understand economic principles.
• In microeconomics, we used the theories of supply and demand; in macroeconomics,
we use the theories of aggregate demand (AD) and aggregate supply (AS).
• This book presents two perspectives on macroeconomics: the Neoclassical perspective
and the Keynesian perspective, each of which has its own version of AD and AS.
Between the two perspectives, you will obtain a good understanding of what drives the
macroeconomy

Policy Tools

• National governments have two sets of tools for influencing the macroeconomy:
• Monetary policy, which involves managing the interest rates and the availability
of credit.
• Fiscal policy, which involves changes in government spending/purchases and
taxes.

What is Gross Domestic Product?

• Gross Domestic Product (GDP): the value of the output of all goods and services
produced within a country in a year
• The measurement of GDP involves counting up the production of millions of different
goods and services—smart phones, cars, music downloads, computers, steel, bananas,
college educations, and all other new goods and services produced in the current
year—and summing them into a total dollar value.
• Take the quantity of everything produced, multiply it by the price at which each product
sold, and add up the total. In 2016, the U.S. GDP totaled $18.6 trillion, the largest GDP in
the world

Final goods and services: goods or services at the furthest stage of their production at the end
end of a year; that is, they have either been sold to consumers, or they are intermediate goods
or raw materials that have not yet been used to produce final goods

What is counted in GDP?

• Final goods and services
• Intermediate goods that have not yet been used in final goods and services
• Raw materials that have been produced, but not yet used in the production of
intermediate or final goods
What is not included in GDP?
• Intermediate goods that have been turned into final goods and services
• Used goods
• Transfer payments
• Non-market activities
• Illegal goods

Calculating GDP

If we know that GDP is the measurement of everything that is produced, we should also ask the
question, who buys all of this production? This demand can be divided into four main parts:
1. Consumer expenditure (consumption)
2. Investment expenditure
3. Government expenditure on goods and services
4. Net export expenditure

Calculating GDP Vocabulary

• Durable Good: a good that last three years or more, such as a car or refrigerator

• Inventory: good that has been produced, but not yet been sold

• National Income: includes all income earned: wages, profits, rent, and profit income

• Nondurable Good: a good that lasts less than three years, such as food and clothing

• Service: product which is intangible (in contrast to goods) such as entertainment,

healthcare, or education

• Structure: building used as residence, factory, office building, retail store, or for other
purposes

• Trade Balance: gap between exports and imports

• Trade Deficit: exists when a nation’s imports exceed its exports and is calculated as
imports – exports
• Trade Surplus: exists when a nation’s exports exceed its imports and is calculated as
exports – imports
Gross National Product
• Gross National Product (GNP): includes what is produced domestically and what is
produced by domestic labor and business abroad in a year
• Includes only what is produced within a country’s borders
• Adds what is produced by domestic business and labor abroad
• Subtracts out any payments sent home to other countries by foreign labor and
businesses located in the U.S.

Net National Product

Net National Product (NNP): GDP minus depreciation

Depreciation: the process by which capital ages and loses value
National Income: all income to businesses and individuals
Personal Income: income made by individuals

Net national product (NNP) is calculated by taking GNP and then subtracting the value of how
much physical capital is worn out, or reduced in value because of aging, over the course of a
year. The process by which capital ages and loses value is called depreciation. The NNP can be
further subdivided into national income, which includes all income to businesses and
individuals, and personal income, which includes only income to people

Nominal and Real Value

• Nominal Value: an economic statistic measured using actual market prices; i.e. nominal
values are not adjusted for inflation; contrast with real value
• Real Value: an economic statistic measured after it has been adjusted for inflation;
contrast with nominal value

Comparing Nominal and Real GDP Vocab

• Simple Growth Rate Formula: the growth rate (or percentage change) of any variable X
over time is (the value of X in the final period – the value of X in the initial period)/(the
value of X in the initial period)
• Real-To-Nominal Formula: the nominal value of some economic variable (e.g. GDP) is
the price level times the real value of that economic variable
Business Cycles

Business Cycle: the relatively short-term movement of the economy from recession to expansion

• Depression: an especially lengthy and deep decline in output

• Peak: during the business cycle, the highest point of output before a recession begins

• Recession: a significant decline in national output typically a minimum of six months

• Trough: during the business cycle, the lowest point of output in a recession, before a
recovery begins

• The most significant human problem associated with recessions and

depressions is that a slowdown in production means that firms need to lay
off or fire some of the workers they have.
• The highest point of the economy, before the recession begins, is called
the peak; conversely, the lowest point of a recession, before a recovery
begins, is called the trough. Thus, a recession lasts from peak to trough, and
an economic upswing runs from trough to peak.
• The movement of the economy from peak to trough and trough to peak is
called the business cycle.

• Overheating, which means the economy is picking up speed leading to increased

inflation.
 • Stagflation, which means the simultaneous occurrence of stagnant growth (or
recession) and inflation. It is a situation where the inflation rate is high, the economic
growth rate slows down, and unemployment is also high.

GDP and Standard of Living

• GDP per capita: GDP divided by the population; often used as a measure of standard of
living
• Standard of Living: all elements that affect people’s happiness, whether these elements
are obtained through market transactions or not
When economists talk about the standard of living, they are referring to the average quantity
(and quality) of goods and services that people in a country can afford to consume. Since real
GDP measures the quantity of goods and services produced, it is common to use GDP per
capita, that is real GDP divided by population, as a measure of economic welfare or standard of
living in a nation.

GDP Per Capita

• Aggregate per Capita Production Function: aggregate production function expressed in

per capita terms: inputs including physical capital per person, human capital per person,
and technology per person are transformed into output measured as GDP per capita

• Aggregate Production Function: the process whereby an economy as a whole turns

economic inputs such as human capital, physical capital, and technology into output
measured as GDP

• Human Capital: the accumulated skills and education of workers

• Innovation: Putting advances in knowledge to use in a new product or service

• Invention: advances in knowledge

• Labor Productivity: Quantity of output produced per worker, or per hour worked

• Production Function: the process whereby a firm turns economic inputs like labor,
machinery, and raw materials into outputs like goods and services used by consumers

• Technological Change: a combination of invention–advances in knowledge–and

innovation
The Aggregate Production Function

• A production function is the process of turning economic inputs like labor, machinery,
and raw materials into outputs like goods and services used by consumers.
• In macroeconomics, the aggregate production function is the relationship between all
the inputs in the economy and GDP

Capital Deepening

• Capital Deepening: an increase by society in the average level of physical and/or human
capital per person
• When society increases the level of capital per person, the result is called capital
deepening. The idea of capital deepening can apply both to additional human capital
per worker and to additional physical capital per worker

Relatively Recent Economic Growth

Industrial Revolution: the widespread use of power-driven machinery and the economic and social
changes that occurred in the first half of the 1800s
Modern Economic Growth: the period of rapid economic growth from 1870 onward

• Modern economic growth-rapid and sustained economic growth is a relatively recent

experience for the human race. Before the last two centuries, although rulers, nobles,
and conquerors could afford some extravagances and although economies rose above
the subsistence level, the average person’s standard of living had not changed much for
centuries
• Progressive, powerful economic and institutional changes started to have a significant
effect in the late eighteenth and early nineteenth centuries
• The Industrial Revolution refers to the widespread use of power-driven machinery and
the economic and social changes that resulted in the first half of the 1800s