CHAPTER 1: MACROECONOMICS
The study of the economic behavior of entire economies,
as measured, for example, by total production and
employment
Macroeconomic Questions
 Why do output and employment sometimes fall
and how can unemployment be reduced?
 What are the sources of price inflation and how
can it be kept under control?
 How can a nation increase its rate of economic
growth?
Objectives of Macroeconomics
OUTPUT
 high level and rapid growth of output
 to provide goods and services that the
population desires
 most comprehensive measure of total output in
an economy is the gross domestic product / gross
national product
 potential output is determined by the economy’s
productive capacity which depends on inputs available
and the economy’s technological efficiency
EMPLOYMENT
 high employment and low unemployment
 When output is falling, the demand for labor falls
and the unemployment rate rises.
STABLE PRICES
 price stability is important because a smoothly
functioning market system requires that prices
accurately and easily convey information about relative
scarcities
Tools of Macroeconomics
FISCAL POLICY
 Denotes the use of taxes and government
expenditures
MONETARY POLICY
 managing the country’s money, credit and
banking system
- restricting money supply leads to higher
interest rates and reduced investments which cause
a decline in GDP and lower inflation
SIX KEY VARIABLES
 Real gross domestic product
 The unemployment rate
 The inflation rate
 The interest rate
 The level of the stock market
 The exchange rate
MACROECONOMIC POLICY
 Growth policy
- aims to accelerate or decelerate long-run economic
growth
 Stabilization policy
- aims to avoid recessions and undue
inflation by keeping total aggregate demand growing
smoothly and unemployment near its NAIRU*.
*Nonaccelerating inflation rate of unemployment (natural
rate of unemployment)
SOME CONCEPTS…
 Business cycles (economic fluctuations)
- the rise and fall of economic activity relative to the
long-term growth trend of the economy
 Expansion
- a period when real GDP is growing
 Recession
- a fall in the level of real GDP for at least six months,
or two quarters of the year
 Depression
- a very severe recession
ROOTS OF MACROECONOMICS
 Most economists and policy makers accepted
the highs and lows of business cycles as being
inevitable, which left them hopeless during the Great
Depression in the 1930s.
The Great Depression in the 1930s
 “America's "Great Depression" began with the
dramatic crash of the stock market on "Black
Thursday", October 24, 1929 when 16 million shares
of stock were quickly sold by panicking investors who
had lost faith in the American economy. At the height
of the Depression in 1933, nearly 25% of the Nation's
total work force, 12,830,000 people, were
unemployed.”
 “Wage income for workers who were lucky
enough to have kept their jobs fell almost 43%
between 1929 and 1933. It was the worst economic
disaster in American history. Farm prices fell so
drastically that many farmers lost their homes and
land. Many went hungry.”
JOHN MAYNARD KEYNES
- The General Theory of Employment, Interest and
Money
 - argued that it is possible for high
unemployment and underutilized capacity to persist in
market economies
- argued that government fiscal and
monetary policies can affect output and thereby
reduce unemployment and shorten economic
downturns
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CHAPTER 2: NATIONAL INCOME ACCOUNTING
Measuring the Economy
• Measurement of aggregate economic activity helps
answer such questions as:
- How much output is being produced? What is it
being used for?
- How much income is being generated?
- What’s happening to prices and wages?
• In the 1930s it was impossible for
macroeconomics to exist in the form we know it today
because many aggregate concepts had not yet been
formulated, or were lacking rigor.
• In the mid-1930s, two Keynesians, Simon
Kuznets and Richard Stone, began to develop this
terminology.
• They developed national income accounting – a
set of rules and definitions for measuring economic
activity in the aggregate economy – that is, in the
economy as a whole.
• For an economy as a whole, income must equal
expenditure because:
- Every transaction has a buyer and a
seller.
- Every dollar of spending by some buyer
is a dollar of income for some seller.
Gross Domestic Product (GDP)
• Each good and service produced and brought to
market has a price which serves as a measure of
value for calculating total output.
- It is impossible to add up all output when output is
counted in physical terms. Accordingly, total output
is measured in monetary terms, with each good or
service valued at its market price.
• The market value of all final goods and services
produced in a country in a period of time, almost
always one year.
• Only goods and services produced in the current
period are included in this year’s GDP.
Gross National Product (GNP)
• Output produced by a nation’s factors of production no
matter where it takes place
• GDP is geographically focused, including only output
produced within a nation’s borders regardless of
whose factors are used
Measuring Total Economic Output of Goods and
Services
 GDP measures the economic activity that occurs
within a country.
 GNP measures the economic activity of the
citizens and businesses of a country.
 Gross National Income (GNI)
 Net foreign factor income is added to GDP to
create the GNP.
- Net foreign factor income is the income from
foreign domestic factor sources minus foreign factor
incomes earned domestically.
- In other words, we must add the foreign income
of our citizens and subtract the income of residents
who are not citizens.
THE MEASUREMENT OF GDP
“GDP is the Market Value . . .”
Output is valued at market prices.
“. . . Of All Final . . .”
It records only the value of final goods, not intermediate
goods (the value is counted only once).
“. . . Goods and Services . . .”
It includes both tangible goods (food, clothing, cars) and
intangible services (haircuts, housecleaning, doctor
visits).
“. . . Produced . . .”
It includes goods and services currently produced, not
transactions involving goods produced in the past.
“. . . Within a Country . . .”
It measures the value of production within the
geographic confines of a country.
“. . . In a Given Period of Time.”
It measures the value of production that takes place
within a specific interval of time, usually a year or a
quarter (three months).
Value Added
• The production of most goods and services involves a
series of stages
• To accurately measure GDP we must distinguish
between intermediate goods and final goods
- Intermediate goods: Goods or services
purchased for use as input in the production of final
goods or services
- Value added: The increase in the market value
of a product that takes place at each stage of the
production process
Value Added Approach Eliminates Double Counting
Value Added in Various Stages of Production
The value added at each stage represents a contribution
to total output.
Two Methods of Calculating GDP
• There are two methods of calculating GDP: the
expenditure approach and the income approach.
• This is because of the national income
accounting identity.
The National Income Accounting Identity
• Although these methods differ, the resulting
GDP is the same, apart from minor “statistical
discrepancies.”
The Expenditure Approach to Measuring GDP
• Economists usually categorize expenditures into four
categories:
- consumption, C
- investment, I
- government purchases, G
- net exports (NX) = exports (X) minus
imports (M) or (X – M).
• Following the expenditure method,
GDP = C + I + G + (X – M)
Consumption
• When individuals receive income, they can
spend it on domestic goods, save it, pay taxes, or buy
foreign goods.
• Consumption is the largest and most important
of the flows (expenditures).
• It is also the most obvious way in which income
received is returned to firms.
3 categories of consumption spending:
 nondurable goods
- tangible consumer items typically consumed or used
up in a relatively short period of time
 durable consumer goods
- longer-lived consumer goods; the most important
category is consumer vehicles
 services
• In boom periods, when GDP is rising rapidly,
expenditures on durables often increase dramatically.
• In years of stagnant or falling GDP, sales of
durable goods often plummet.
• By contrast, sales of nondurables tend to be
more stable over time because purchases of such
goods are more difficult to shift from one time period to
another.
• Services are intangible items of value, as
opposed to physical goods.
• As incomes have risen, service expenditures
have been growing faster than spending on goods
Investment
• The portion of income that individuals save
leaves the spending stream and goes into financial
markets.
• Business spending on equipment, structures,
and inventories is counted as part of gross private
investment, together with household spending on new
owner-occupied housing.
• Investment, as used by economists, refers to the - Transfer payments are not included in government
creation of capital goods whose purpose is to produce purchases because that spending does not go to
other goods. purchase newly produced goods or services.
• This definition of investment deviates from the
Net Exports
popular use of that term.
- Spending on foreign goods escapes the system and
• For instance, purchases of stock are not an
does not add to domestic production, thus spending
investment as defined by economists (i.e., an increase
on imports are subtracted from total expenditures.
in capital goods).
- Exports to foreign nations are added to total
• Sooner or later, plant and equipment wear out.
• This wearing-out process is called depreciation expenditures.
– the decrease in an asset's value. - These flows are usually combined into net exports
• Economists differentiate between total or gross (exports minus imports).
private domestic investment and the new investment GDP and NDP
that is above and beyond replacement investment. - Net domestic product (NDP) is the sum of
• Net private investment – gross private consumption expenditures, government
investment less depreciation. expenditures, net foreign expenditures, and
Three categories of investment purchases: investment less depreciation.
1. business fixed investment,
NDP  GDP – depreciation
- sometimes called producer goods,
- include all spending on capital goods that
- NDP is actually preferable to GDP as an expression
increase our future production capabilities
of a nation's domestic output.
- machinery, tools, and factory buildings,
- Since it is so hard to measure depreciation in the
2. inventory investment (changes in inventories). real world, economists use capital consumption
- all businesses purchase that add to inventories to allowance rather than depreciation.
meet customer demands. - The distinction between GDP and NDP is mirrored in
the difference between gross investment and net
3. residential investment investment
- residential construction
Income
• In recent years, investment expenditures have • Personal Income measures the total amount of
generally been around 15 percent of gross domestic income received by households and non-corporate
product. businesses.
• Investment spending is the most volatile • Personal Disposable Income (PDI) is the
category of GDP, however, and tends to fluctuate personal income available to individuals after taxes.
considerably with changing business conditions.
• When the economy is booming, investment
purchases tend to increase dramatically.
Real Versus Nominal GDP
• In downturns, the reverse happens.
Nominal GDP values the production of goods and
Government Expenditures
services at current prices.
• Government payments for goods and services
or investment in equipment and structures are referred Real GDP values the production of goods and services
to as government expenditures. at constant prices.
• There is a connection between the government
and the financial markets.
• If the government runs a deficit, it must borrow
from financial markets to make up the difference.
• When individuals pay taxes, those taxes are
either spent by government on goods and services or
are returned to individuals in the form of transfer
payments.

Transfer Payments
 • GDP per capita (GDP per person) tells us the
income and expenditure of the average person in the
economy.

GDP per Capita

Base year- the year used for comparative analysis; the = Total GDP divided by total population;
basis for indexing price changes
Average GDP
GDP Deflator - commonly used as a measure of a country’s
• a measure of the price level calculated as the standard of living
ratio of nominal GDP to real GDP times 100. - measures of per capita GDP tell us nothing
- It tells us the rise in nominal GDP that is about how GDP is actually distributed or used
attributable to a rise in prices rather than a rise in the
• Higher GDP per person indicates a higher
quantities produced.
standard of living.
N o m in a l G D P • GDP is not a perfect measure of the happiness
G D P d e fla to r = 100
R eal G D P or quality of life, however.
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CHAPTER 3

Who is unemployed?
• does not have a job
• must be actively looking for work
Converting Nominal GDP to Real GDP
Unemployment rate
N o m in a l G D P 20X X
R e a l G D P 20X X  100 • the percentage of a nation’s labor force that is
G D P d e f la to r20 X X unemployed
• Formula:
Measurement problems
• Methods of calculating GDP entail  
measurement problems in accounting for all economic
activity
- Non-Market Activities - Goods and
services produced that are not sold in a market
- Unreported Income - Market activities Labor force
not reported to tax or census authorities • The labor force is the number of people over the age
of 15 who are either employed or unemployed.
Calculating GDP: Some Examples
• Formula:
• Selling your car to a neighbor does not add to
Labor force = employed + unemployed
GDP.
• Selling your car to a used car dealer who sells • The civilian labor force figure excludes (they are not
your car to someone else for a higher price, does add considered currently available for employment.)
to GDP. - those in the armed services, prison or mental
• The value added is the dealer's services. hospitals
• Selling a stock or bond does not add to GDP. - full-time homemakers
• The stock broker's commission for the sales - retirees
does add to GDP. - children
• Pension payments, welfare payments, - full-time students
employment insurance benefits, and other government
transfer payments are not included in GDP.
• The work of unpaid house spouses does not Labor force participation rate
appear in GDP calculations. • The percentage of the population that is in the labor
force is called the labor force participation rate.
GDP As A Measure of Economic Well-Being • Formula:
• GDP is the best single measure of the economic
well-being of a society. LFPR = (labor force / adult population*) X 100
*15 years and above
Types of Unemployment
1.Frictional unemployment
• people are temporarily between jobs
• is short term and results from the normal turnover
in the labor market

2.Structural unemployment
• people lack the necessary skills for available jobs

3.Cyclical unemployment
• results from short-term cyclical fluctuations in the
economy

Major Categories of Unemployed Workers

• job losers (temporarily laid off or fired)
• job leavers (quit)
• re-entrants (worked before and now reentering labor
force)
• new entrants (entering the labor force for first time—
primarily teenagers).

Other concepts
• underemployed
• overemployed
• “Discouraged” workers

Goal: Full employment

• Zero Unemployment is always impossible in a market
economy.
• But we strive for Full Employment where no cyclical
unemployment exists in the economy.
• An unemployment rate of about 4-6 percent is normal
during full employment.