Macroeconomics Summary Notes: Midsemester Exams
Chapter 1: Introduction to Macroeconomics
Macroeconomics is the study of the performance of the national economy as well as
the policies used to improve that performance
Chapter 2: Measuring Economic Activity
GDP: Measuring the nation’s output:
o GDP is the market value of the final goods (Q) and services produced in a
country during a given period:
What about public goods and services Measure by determining costs
o Real GDP per capita is the total GDP divided by the total population of the
country which indicates the total standard of living in a country. However, it
hides inequality.
How to measure GDP (3 Methods)
i) Value-added is what the firm adds to the value of the produced inputs it buys
from other firms i.e., value of the firms output less value of purchases of
intermediate goods
ii) Expenditure method assumes all current production by firms is either bought
by household other firms, government and foreigners or left unsold as
inventories.
C: Consumption expenditure. Spending by households on goods and
services, not including spending on new houses (around 55% of GDP
on average)
I: Investment. Spending by firms on new buildings machinery and
inventories, plus spending by households on new houses (23%)
G: Government expenditure. Spending by federal state and local
governments on goods and services (22%)
NX: Net exports. Expenditure on exports (X) minus the expenditure on
(M) (net 0%)
GDP=Y =C+ I +G+ NX
iii) Income Method, when a good or service is sold the revenues from the sale are
distributed to the workers and the owners of the capital involved in the
production
GDP also equals labour income (wages) plus capital income
(profits/rent/interest) from the production
Nominal GDP is current production at ‘current prices’
o Problem: it can mislead when comparing GDP over time
Real GDP is the current production at ‘base year prices’
o Real GDP is not that same as economic wellbeing:
Leisure time is excluded
Non-market economic activities are excluded
Environmental quality and resource depletion are excluded
Quality of life is excluded
, Chapter 3: Measuring the price level and inflation
Consumer Price Index
o A CPI is a measure of the weighted average of the percentage change in the
prices paid by households for a fixed basket of goods and services
o The way CPI is calculated is basically an application of Laspeyres index:
weighted average of price changes through time
cost of base year basket ∈current year
CPI=
cost of base year basket ∈base year
o CPI can be used to convert real into nominal via a process called “indexing”
Nominal
=Real
CPI
o The CPI overstates the actual level of inflation in the economy for two
significant reasons:
1. Quality adjustment bias
2. Substitution bias (For example when the price of apples rises but
the price of oranges does not, consumers are likely to switch their
consumption a little bit away from apples and toward oranges, and
thereby avoid experiencing the entire price increase
Inflation
o Inflation rate is the annual percentage rate of change in the average price level,
as measure by CPI for example
o Inflation rate in December 2013 is:
CPIDec 2013−CPIDec 2012
x 100
CPIDec 2012
o RBA inflation target is between 2-3% (normally)
o Why do we not like to much inflation
Shoe leather costs
You don’t want to hold too much money in your pocket,
otherwise you don’t get access to interest rates or other assets
therefore there is an opportunity cost
Noise in the price system
Price change usually indicates changes in demand however to
much inflation creates noise in price system as price changes do
not reflect demand anymore
Distortions of the tax system
Without and indexed tax system, you may be pushed into
higher tax bracket because nominal income increased whilst
real income decreased
Unexpected redistribution of wealth
Lender loses when there is inflation and borrower gains
Interference with long-run planning
Retirement
Menu Costs
Inflation and interest rates
o Inflation and interest rates are closely linked
o Real interest rate {r}: The percentage increase in the real purchasing power of
a financial asset
Reflects the true cost of borrowing
Chapter 1: Introduction to Macroeconomics
Macroeconomics is the study of the performance of the national economy as well as
the policies used to improve that performance
Chapter 2: Measuring Economic Activity
GDP: Measuring the nation’s output:
o GDP is the market value of the final goods (Q) and services produced in a
country during a given period:
What about public goods and services Measure by determining costs
o Real GDP per capita is the total GDP divided by the total population of the
country which indicates the total standard of living in a country. However, it
hides inequality.
How to measure GDP (3 Methods)
i) Value-added is what the firm adds to the value of the produced inputs it buys
from other firms i.e., value of the firms output less value of purchases of
intermediate goods
ii) Expenditure method assumes all current production by firms is either bought
by household other firms, government and foreigners or left unsold as
inventories.
C: Consumption expenditure. Spending by households on goods and
services, not including spending on new houses (around 55% of GDP
on average)
I: Investment. Spending by firms on new buildings machinery and
inventories, plus spending by households on new houses (23%)
G: Government expenditure. Spending by federal state and local
governments on goods and services (22%)
NX: Net exports. Expenditure on exports (X) minus the expenditure on
(M) (net 0%)
GDP=Y =C+ I +G+ NX
iii) Income Method, when a good or service is sold the revenues from the sale are
distributed to the workers and the owners of the capital involved in the
production
GDP also equals labour income (wages) plus capital income
(profits/rent/interest) from the production
Nominal GDP is current production at ‘current prices’
o Problem: it can mislead when comparing GDP over time
Real GDP is the current production at ‘base year prices’
o Real GDP is not that same as economic wellbeing:
Leisure time is excluded
Non-market economic activities are excluded
Environmental quality and resource depletion are excluded
Quality of life is excluded
, Chapter 3: Measuring the price level and inflation
Consumer Price Index
o A CPI is a measure of the weighted average of the percentage change in the
prices paid by households for a fixed basket of goods and services
o The way CPI is calculated is basically an application of Laspeyres index:
weighted average of price changes through time
cost of base year basket ∈current year
CPI=
cost of base year basket ∈base year
o CPI can be used to convert real into nominal via a process called “indexing”
Nominal
=Real
CPI
o The CPI overstates the actual level of inflation in the economy for two
significant reasons:
1. Quality adjustment bias
2. Substitution bias (For example when the price of apples rises but
the price of oranges does not, consumers are likely to switch their
consumption a little bit away from apples and toward oranges, and
thereby avoid experiencing the entire price increase
Inflation
o Inflation rate is the annual percentage rate of change in the average price level,
as measure by CPI for example
o Inflation rate in December 2013 is:
CPIDec 2013−CPIDec 2012
x 100
CPIDec 2012
o RBA inflation target is between 2-3% (normally)
o Why do we not like to much inflation
Shoe leather costs
You don’t want to hold too much money in your pocket,
otherwise you don’t get access to interest rates or other assets
therefore there is an opportunity cost
Noise in the price system
Price change usually indicates changes in demand however to
much inflation creates noise in price system as price changes do
not reflect demand anymore
Distortions of the tax system
Without and indexed tax system, you may be pushed into
higher tax bracket because nominal income increased whilst
real income decreased
Unexpected redistribution of wealth
Lender loses when there is inflation and borrower gains
Interference with long-run planning
Retirement
Menu Costs
Inflation and interest rates
o Inflation and interest rates are closely linked
o Real interest rate {r}: The percentage increase in the real purchasing power of
a financial asset
Reflects the true cost of borrowing
