Macro economics
Table of Contents
CHAPTER 20: NATION’S WELL BEING................................................................................................................3
THE MEASUREMENT AND COMPONENTS OF GDP.........................................................................................................3
REAL VS. NOMINAL GDP........................................................................................................................................4
GDP AND ECONOMIC WELL-BEING.................................................................................................................4
CHAPTER 21: MEASURING THE COST OF LIVING...............................................................................................5
THE CONSUMER PRICES INDEX..................................................................................................................................5
PROBLEMS IN MEASURING THE COST OF LIVING................................................................................................................5
CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION...........................................................6
INDEXATION & REAL AND NOMINAL INTEREST RATES.........................................................................................................6
CHAPTER 22: PRODUCTION AND GROWTH......................................................................................................7
ECONOMICS GROWTH AROUND THE WORLD...............................................................................................................7
GROWTH THEORY.................................................................................................................................................7
PRODUCTIVITY: ITS ROLE AND DETERMINATES.............................................................................................................7
ECONOMICS GROWTH............................................................................................................................................8
LONG-RUM EQUILIBRIUM.............................................................................................................................................8
CAUSES OF GROWTH..............................................................................................................................................9
PUBLIC POLICY......................................................................................................................................................9
NOTES CHAPTER 21 + 22:....................................................................................................................................10
CHAPTER 23: UNEMPLOYMENT......................................................................................................................11
IDENTIFYING UNEMPLOYMENT...............................................................................................................................11
CAUSES OF UNEMPLOYMENT.................................................................................................................................12
LABOUR MARKET IMPERFECTIONS................................................................................................................................12
NATURAL RATE OF UNEMPLOYMENT.......................................................................................................................12
COST OF UNEMPLOYMENT.....................................................................................................................................13
CHAPTER 24: SAVING, INVESTMENT AND THE FINANCIAL SYSTEM.................................................................14
FINANCIAL INSTITUTIONS IN THE ECONOMY...............................................................................................................14
THE MEANING OF SAVING AND INVESTMENT..................................................................................................................14
SAVING AND INVESTMENT IN THE NATIONAL INCOME ACCOUNT....................................................................................15
THE MARKET FOR LOANABLE FUNDS........................................................................................................................15
DEMAND AND SUPPLY FOR LOANABLE FUNDS.................................................................................................................15
CHAPTER 31: BUSINESS CYCLE........................................................................................................................16
TREND GROWTH RATES........................................................................................................................................16
CAUSES OF CHANGES IN THE BUSINESS CYCL................................................................................................16
1
,CHAPTER 32: KEYNESIAN ECONOMICS AND IS-LM ANALYSIS..........................................................................17
THE KEYNESIAN CROSS.........................................................................................................................................17
THE EQUILIBRIUM OF THE ECONOMY.............................................................................................................................17
THE MULTIPLIER EFFECT........................................................................................................................................18
THE IS AND LM CURVES................................................................................................................................19
THE IS CURVE..........................................................................................................................................................19
THE LM CURVE........................................................................................................................................................20
GENERAL EQUILIBRIUM USING THE IS–LM MODEL.......................................................................................20
SHIFTS IN THE ISLM MODEL.......................................................................................................................................21
OVERVIEW CURVES.............................................................................................................................................22
CHAPTER 33: AGGREGATE DEMAND AND AGGREGATE SUPPLY.....................................................................23
THE AGGREGATE DEMAND CURVE (AD)...................................................................................................................23
THE AGGREGATE SUPPLY CURVES (AS).....................................................................................................................24
LONG RUN AGGREGATE SUPPLY CURVE........................................................................................................................24
SHORT RUN AGGREGATE SUPPLY CURVE.......................................................................................................................24
ECONOMICS FLUCTUATIONS...................................................................................................................................25
THE EFFECTS OF A SHIFT IN AGGREGATE DEMAND..........................................................................................................25
THE EFFECTS OF A SHIFT IN AGGREGATE SUPPLY............................................................................................................25
CHAPTER 34: INFLUENCE OF MONETARY AND FINANCIAL POLICY ON AGGREGATE DEMAND........................26
HOW MONETARY POLICY INFLUENCES AGGREGATE DEMAND......................................................................26
THE DOWNWARDS SLOPE OF THE AGGREGATE DEMAND CURVE.......................................................................................27
CHANGE IN THE MONEY SUPPLY...................................................................................................................................27
HOW FISCAL POLICY INFLUENCES AGGREGATE DEMAND.................................................................................28
CHANGE IN GOVERNMENT PURCHASES..........................................................................................................................28
CHANGE IN TAXES.....................................................................................................................................................28
USING POLICY TO STABILIZE THE ECONOMY.................................................................................................29
CHAPTER 35: THE SHORT-RUN TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT .............................29
THE PHILIPS CURVE..............................................................................................................................................29
AGGREGATE DEMAND, AGGREGATE SUPPLY AND THE PHILLIPS CURVE...............................................................................30
THE LONG-RUN PHILLIPS CURVE.................................................................................................................................30
2
, Macro economics
Macroeconomics is the study of the economy as a whole. The goal of macroeconomics is to explain the economic
changes that affect many households, firms and markets simultaneously.
CHAPTER 20: NATION’S WELL BEING
GDP measures two things at once: the total income and the total expenditure. This are really the same because every
buyer has a seller and the other way around.
THE MEASUREMENT AND
COMPONENTS OF GDP
Gross domestic product (GDP) = Market value of all new final goods and services produced within a country in a given
period of time
Y = C+I+G+(X-M) or Y = C+I+G+NX
Average supply = average demand
Production = Spending
Y = GDP
C = Consumption spending by households on goods and services, with the exception of purchases of new housing
I = Investment the purchase of goods that will be used in the future to produce more goods and services. It is the sum
of purchases of capital equipment, inventories and structures, including household purchases of new housing. Firms
G = Government purchase spending on goods and services by local and national governments.
NX = Net Exports = (X-M) = spending on domestically produced goods and services by foreigners (exports) minus spending
on foreign goods by domestic residents (imports)
Imports (bought but not produced in the country)
Transfer payment = government speeding’s where no good or service is exchange (AOW)
GDP per capita = gross domestic product divided by the population of a country to give a measure of national income per
head
3
,Leakages = Taxes, Savings, imports
REAL VS. NOMINAL GDP
If total spending rises from one year to the next, one of two things must be true (or a combination of the two):
1. the economy is producing a larger output of goods and services (a real increase)
2. goods and services are being sold at higher prices (a nominal increase).
Real GDP = the measure of the value of output in the economy which takes into account changes in prices over time. (To
measure the total quantity of goods and services the economy is producing that is not affected by changes in the prices of
those goods and services.)
GDP at constant prices gross domestic product calculated using prices that existed at a particular base year which takes
into account changes in inflation over time. This is used to calculate the real GDP.
GDP figures produced without taking into consideration the change in prices over time are called GDP at current or
market prices and are calculated by multiplying the output of goods and services by the price of those goods and services
in the reporting year.
Nominal GDP = the production of goods and services valued at current prices
GDP deflator = a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. The GDP
deflator is one measure that economists use to monitor the average level of prices in the economy. If it increases
compared to the year before than the price level has increased
GDP measures three things at once: the total income earned by everyone in the economy, the total expenditure on the
economy’s output of goods and services and the value of the output produced.
GDP AND ECONOMIC WELL-BEING
GDP is a good measure of economic well-being because people prefer higher to lower incomes. But it is not a perfect
measure of well-being. There are multiple things excluded from the GDP
Limitations of GDP
Household work
Leisure
Quality of environment
Income distribution
Voluntary work
Illegal work
Old houses (period of time)
Products that are not final (wheel for car)
4
, CHAPTER 21: MEASURING THE COST OF LIVING
THE CONSUMER PRICES INDEX
The consumer prices index (CPI) is a measure of the overall prices of the goods and services bought by a typical
consumer. The consumer prices index is used to monitor changes in the cost of living over time. (index=level)
Steps to calculate the consumer price index and the inflation rate
Step 1: determine a fixed basket of goods what does the consumer buy more from and is therefore more important to
them. This should be given a greater weight in measuring the cost of living.
Step 2: find the prices
Step 3: compute the basket’s costs step1 * step 2 = step 3
Step 4: choose one year as base year (oldest) and compute the
consumer price index the price of the basket of goods and
services in each year is divided by the price of the basket in the
base year, and this ratio is then multiplied by 100. The resulting
number is the CPI.
Value T/ value base year * 100 = CPI
Step 5: compute the inflation rate inflation rate the
percentage change in the price index from the preceding period
Producer prices index (PPI) a measure of the prices of a
basket of goods and services bought by firms
Inflation is n-o/o and should be 2%
PROBLEMS IN MEASURING THE COST OF LIVING
1. Substitution bias If a price index is computed assuming a fixed basket of goods, it ignores the possibility of consumer
substitution (choosing other goods that are cheaper) and, therefore, overstates the increase in the cost of living from one
year to the next.
2. The introduction of new goods results in more variety, in turn, makes each pound more valuable, so consumers
need fewer pounds to maintain any given standard of living. Yet because the CPI is based on a fixed basket of goods and
services, it does not reflect this change in the purchasing power of the pound.
3. Unmeasured quality change If the quality of a good deteriorates from one year to the next, the effective value of a
pound falls, even if the price of the good stays the same. Similarly, if the quality rises from one year to the next, the
effective value of a pound rises. (quality is difficult to measure)
5
Table of Contents
CHAPTER 20: NATION’S WELL BEING................................................................................................................3
THE MEASUREMENT AND COMPONENTS OF GDP.........................................................................................................3
REAL VS. NOMINAL GDP........................................................................................................................................4
GDP AND ECONOMIC WELL-BEING.................................................................................................................4
CHAPTER 21: MEASURING THE COST OF LIVING...............................................................................................5
THE CONSUMER PRICES INDEX..................................................................................................................................5
PROBLEMS IN MEASURING THE COST OF LIVING................................................................................................................5
CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION...........................................................6
INDEXATION & REAL AND NOMINAL INTEREST RATES.........................................................................................................6
CHAPTER 22: PRODUCTION AND GROWTH......................................................................................................7
ECONOMICS GROWTH AROUND THE WORLD...............................................................................................................7
GROWTH THEORY.................................................................................................................................................7
PRODUCTIVITY: ITS ROLE AND DETERMINATES.............................................................................................................7
ECONOMICS GROWTH............................................................................................................................................8
LONG-RUM EQUILIBRIUM.............................................................................................................................................8
CAUSES OF GROWTH..............................................................................................................................................9
PUBLIC POLICY......................................................................................................................................................9
NOTES CHAPTER 21 + 22:....................................................................................................................................10
CHAPTER 23: UNEMPLOYMENT......................................................................................................................11
IDENTIFYING UNEMPLOYMENT...............................................................................................................................11
CAUSES OF UNEMPLOYMENT.................................................................................................................................12
LABOUR MARKET IMPERFECTIONS................................................................................................................................12
NATURAL RATE OF UNEMPLOYMENT.......................................................................................................................12
COST OF UNEMPLOYMENT.....................................................................................................................................13
CHAPTER 24: SAVING, INVESTMENT AND THE FINANCIAL SYSTEM.................................................................14
FINANCIAL INSTITUTIONS IN THE ECONOMY...............................................................................................................14
THE MEANING OF SAVING AND INVESTMENT..................................................................................................................14
SAVING AND INVESTMENT IN THE NATIONAL INCOME ACCOUNT....................................................................................15
THE MARKET FOR LOANABLE FUNDS........................................................................................................................15
DEMAND AND SUPPLY FOR LOANABLE FUNDS.................................................................................................................15
CHAPTER 31: BUSINESS CYCLE........................................................................................................................16
TREND GROWTH RATES........................................................................................................................................16
CAUSES OF CHANGES IN THE BUSINESS CYCL................................................................................................16
1
,CHAPTER 32: KEYNESIAN ECONOMICS AND IS-LM ANALYSIS..........................................................................17
THE KEYNESIAN CROSS.........................................................................................................................................17
THE EQUILIBRIUM OF THE ECONOMY.............................................................................................................................17
THE MULTIPLIER EFFECT........................................................................................................................................18
THE IS AND LM CURVES................................................................................................................................19
THE IS CURVE..........................................................................................................................................................19
THE LM CURVE........................................................................................................................................................20
GENERAL EQUILIBRIUM USING THE IS–LM MODEL.......................................................................................20
SHIFTS IN THE ISLM MODEL.......................................................................................................................................21
OVERVIEW CURVES.............................................................................................................................................22
CHAPTER 33: AGGREGATE DEMAND AND AGGREGATE SUPPLY.....................................................................23
THE AGGREGATE DEMAND CURVE (AD)...................................................................................................................23
THE AGGREGATE SUPPLY CURVES (AS).....................................................................................................................24
LONG RUN AGGREGATE SUPPLY CURVE........................................................................................................................24
SHORT RUN AGGREGATE SUPPLY CURVE.......................................................................................................................24
ECONOMICS FLUCTUATIONS...................................................................................................................................25
THE EFFECTS OF A SHIFT IN AGGREGATE DEMAND..........................................................................................................25
THE EFFECTS OF A SHIFT IN AGGREGATE SUPPLY............................................................................................................25
CHAPTER 34: INFLUENCE OF MONETARY AND FINANCIAL POLICY ON AGGREGATE DEMAND........................26
HOW MONETARY POLICY INFLUENCES AGGREGATE DEMAND......................................................................26
THE DOWNWARDS SLOPE OF THE AGGREGATE DEMAND CURVE.......................................................................................27
CHANGE IN THE MONEY SUPPLY...................................................................................................................................27
HOW FISCAL POLICY INFLUENCES AGGREGATE DEMAND.................................................................................28
CHANGE IN GOVERNMENT PURCHASES..........................................................................................................................28
CHANGE IN TAXES.....................................................................................................................................................28
USING POLICY TO STABILIZE THE ECONOMY.................................................................................................29
CHAPTER 35: THE SHORT-RUN TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT .............................29
THE PHILIPS CURVE..............................................................................................................................................29
AGGREGATE DEMAND, AGGREGATE SUPPLY AND THE PHILLIPS CURVE...............................................................................30
THE LONG-RUN PHILLIPS CURVE.................................................................................................................................30
2
, Macro economics
Macroeconomics is the study of the economy as a whole. The goal of macroeconomics is to explain the economic
changes that affect many households, firms and markets simultaneously.
CHAPTER 20: NATION’S WELL BEING
GDP measures two things at once: the total income and the total expenditure. This are really the same because every
buyer has a seller and the other way around.
THE MEASUREMENT AND
COMPONENTS OF GDP
Gross domestic product (GDP) = Market value of all new final goods and services produced within a country in a given
period of time
Y = C+I+G+(X-M) or Y = C+I+G+NX
Average supply = average demand
Production = Spending
Y = GDP
C = Consumption spending by households on goods and services, with the exception of purchases of new housing
I = Investment the purchase of goods that will be used in the future to produce more goods and services. It is the sum
of purchases of capital equipment, inventories and structures, including household purchases of new housing. Firms
G = Government purchase spending on goods and services by local and national governments.
NX = Net Exports = (X-M) = spending on domestically produced goods and services by foreigners (exports) minus spending
on foreign goods by domestic residents (imports)
Imports (bought but not produced in the country)
Transfer payment = government speeding’s where no good or service is exchange (AOW)
GDP per capita = gross domestic product divided by the population of a country to give a measure of national income per
head
3
,Leakages = Taxes, Savings, imports
REAL VS. NOMINAL GDP
If total spending rises from one year to the next, one of two things must be true (or a combination of the two):
1. the economy is producing a larger output of goods and services (a real increase)
2. goods and services are being sold at higher prices (a nominal increase).
Real GDP = the measure of the value of output in the economy which takes into account changes in prices over time. (To
measure the total quantity of goods and services the economy is producing that is not affected by changes in the prices of
those goods and services.)
GDP at constant prices gross domestic product calculated using prices that existed at a particular base year which takes
into account changes in inflation over time. This is used to calculate the real GDP.
GDP figures produced without taking into consideration the change in prices over time are called GDP at current or
market prices and are calculated by multiplying the output of goods and services by the price of those goods and services
in the reporting year.
Nominal GDP = the production of goods and services valued at current prices
GDP deflator = a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. The GDP
deflator is one measure that economists use to monitor the average level of prices in the economy. If it increases
compared to the year before than the price level has increased
GDP measures three things at once: the total income earned by everyone in the economy, the total expenditure on the
economy’s output of goods and services and the value of the output produced.
GDP AND ECONOMIC WELL-BEING
GDP is a good measure of economic well-being because people prefer higher to lower incomes. But it is not a perfect
measure of well-being. There are multiple things excluded from the GDP
Limitations of GDP
Household work
Leisure
Quality of environment
Income distribution
Voluntary work
Illegal work
Old houses (period of time)
Products that are not final (wheel for car)
4
, CHAPTER 21: MEASURING THE COST OF LIVING
THE CONSUMER PRICES INDEX
The consumer prices index (CPI) is a measure of the overall prices of the goods and services bought by a typical
consumer. The consumer prices index is used to monitor changes in the cost of living over time. (index=level)
Steps to calculate the consumer price index and the inflation rate
Step 1: determine a fixed basket of goods what does the consumer buy more from and is therefore more important to
them. This should be given a greater weight in measuring the cost of living.
Step 2: find the prices
Step 3: compute the basket’s costs step1 * step 2 = step 3
Step 4: choose one year as base year (oldest) and compute the
consumer price index the price of the basket of goods and
services in each year is divided by the price of the basket in the
base year, and this ratio is then multiplied by 100. The resulting
number is the CPI.
Value T/ value base year * 100 = CPI
Step 5: compute the inflation rate inflation rate the
percentage change in the price index from the preceding period
Producer prices index (PPI) a measure of the prices of a
basket of goods and services bought by firms
Inflation is n-o/o and should be 2%
PROBLEMS IN MEASURING THE COST OF LIVING
1. Substitution bias If a price index is computed assuming a fixed basket of goods, it ignores the possibility of consumer
substitution (choosing other goods that are cheaper) and, therefore, overstates the increase in the cost of living from one
year to the next.
2. The introduction of new goods results in more variety, in turn, makes each pound more valuable, so consumers
need fewer pounds to maintain any given standard of living. Yet because the CPI is based on a fixed basket of goods and
services, it does not reflect this change in the purchasing power of the pound.
3. Unmeasured quality change If the quality of a good deteriorates from one year to the next, the effective value of a
pound falls, even if the price of the good stays the same. Similarly, if the quality rises from one year to the next, the
effective value of a pound rises. (quality is difficult to measure)
5
