Lecture 1

Introduction and Measurement

Issues
 Topics

• What is macroeconomics?
• Measuring GDP
• Nominal and real GDP and price indices
• Savings, wealth and capital
• Labor market measurement
• GDP, economic growth, business cycles.
• Macroeconomic models.
• Understanding recent and current macroeconomic events.
 What is Macroeconomics?

• Models built to explain macroeconomic phenomena.

• The important pheonomena are long-run growth and
business cycles.
• Approach is to build up macroeconomic analysis from
microeconomic principles.
 A Precise Definition of GDP
• 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., USD)

Things  that  don’t  have  a  market  value  are  excluded,  e.g.,  
housework you do for yourself.
 A Precise Definition of GDP
• 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 included in the calculation
of  this  year’s  GDP.
 A Precise Definition of GDP
• 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.
 A Precise Definition of GDP
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 part of the US GDP; it is part of
the  United  Kingdom’s  GDP.  
Even goods produced by foreigners within US borders are
included in US GDP
 A Precise Definition of GDP
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 Ford produced a Mustang in December 2008

but the car was not sold until January 2009, then that
Mustang will be included in the GDP of the period in which
it was produced— 2008.
Usually a year or a quarter.
People earn income from producing goods and services, and then
use this income (Y) to buy goods and services (C, I, G, X).
• GDP Measured Using: (i) the product approach; (ii)
the expenditure approach; (iii) the income
approach.

• National Income Accounting Example

Fictional Island Economy
Coconut Producer, Restaurant, Consumers, Government
Coconut Producer Restaurant

After-Tax Profits
Government Consumers
GDP Using the Product Approach
GDP Using the Expenditure Approach
GDP Using the Income Approach
• Gross Domestic Product (GDP)
• C: consumption
• I: investment
• G: government expenditure
• The trade balance (TB) : EX-IM

GDP C I G EX IM
Gross Gross All exports, All imports,
domestic national final & intermediate final & intermediate
product expenditure
GNE Trade balance
TB
Gross Domestic Product for 2011
 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.
 Nominal and Real GDP and Price Indices

• Price Index: Weighted average of a set of observed prices that

gives a measure of the price level.

• Price indices allow us to measure the inflation rate – the rate of

change in the price level.

• A measure of the inflation rate allows us to determine how much

of an increase in GDP is nominal and how much is real.
Data for Real GDP Example
Nominal GDP and Chain-Weighted Real GDP
Implicit GDP Price Deflators, Example
Inflation Rate Calculated from the CPI and from
the Implicit GDP Price Deflator
The Price Level as Measured by the CPI and the
Implicit GDP Price Deflator
 Problems in Measuring Real GDP and the Price
Level

• The relative prices of goods change over time – a problem for CPI
measurement.
• The quality of goods and services changes over time.
• New goods and services are introduced, and some goods and
services become obsolete.
 Gross Domestic Product, Economic Growth, and
Business Cycles
• The time series of GDP can be separated into trend and
business cycle components.
Natural Logarithm of Per Capita Real GDP
and Trend
Percentage Deviations from Trend in
Per Capita Real GDP
 Measuring Unemployment

• The official US unemployment rate (U-3) produced by

Bureau of Labor Statistics (BLS) in the U.S. Department of
Labor

• The Current Population Survey (CPS) is a monthly survey of

60,000 households conducted by the Bureau of Census for
the BLS.

• Based on adults (16 yrs or older)/non-institutional (not in jail

or hospital)/civilian population/full or part-time
 Measuring Unemployment

BLS divides the US population into 3 groups:

– Employed: paid employees, self-employed, and unpaid workers
in a family business
– Unemployed: people not working who have actively looked for
work in the last 4 weeks
– Not in the labor force: everyone else

The labor force is the total number of workers, including the

employed and unemployed.
 Measuring Unemployment

Labor force participation rate:

% of the adult (working-age) population that is in the labor force

labor force labor force

participation rate
= 100 x
adult population
 Measuring Unemployment

Unemployment rate:
% of the labor force (not adult population) that is unemployed

# of unemployed
Unemp. Rate = 100 x
labor force
 Measuring Unemployment

Adult population of the U.S. by group January 2010

# of employed 138.3 million

# of unemployed 14.8 million
Not in labor force 83.7 million

Labor force = employed + unemployed

= 138.3 + 14.8 = 153.1 million

Population = labor force + not in labor force

= 153.1 + 83.7 = 236.8 million
 Measuring Unemployment

Adult population of the U.S. by group January 2010

# of employed 138.3 million

# of unemployed 14.8 million
Not in labor force 83.7 million
Labor Force 153.1 million
*Population 236.8 million

LF Participation rate = 100 x (labor force)/(adult population)

= 100 x 153.1/236.8 = 64.7%

Unemp. Rate = 100 x (unemployed)/(labor force)

= 100 x 14.8/153.1 = 9.7%
 What Happens to the Unemp. Rate?

Sue loses her job and begins looking for a new one.

Unemployment rate rises

A rising unemployment rate gives the impression that the labor
market is worsening, and it is.
 What Happens to the Unemp. Rate?
Jon has been out of work since last year, becomes discouraged,
and stops looking for work.

Discouraged workers
would like to work but have given up looking for jobs
classified  as  “not  in  the  labor  force”  rather  than  “unemployed”  
Unemployment rate falls because Jon is no longer counted as
unemployed*.
A falling unemployment rate gives the impression that the labor
market is improving, but it is not.
 What Happens to the Unemp. Rate?

Sam loses his $80,000 job. He takes a part-time job at

McDonald’s  until  he  finds  a  better  one.

The unemployment rate remains unchanged because a person is

“employed”  whether  they  work  full  or  part  time.  

Things are worse, but the unemployment rate fails to show it.
The Unemployment Rate for the United States
 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.
 Basic Structure of a Macroeconomic Model

• Consumers and firms

• The set of goods that consumers consume
• Consumers’  preferences
• The production technology
• Resources available
 What do we learn from macroeconomic analysis?

• What is produced and consumed in the economy is determined

jointly  by  the  economy’s  productive  capacity  and  the  preferences  
of consumers.
• In free market economies, there are strong forces that tend to
produce socially efficient economic outcomes.
• Unemployment is painful for individuals, but it is a necessary evil
in modern economies.
• Improvements  in  a  country’s  standard  of  living  are  brought  about  
in the long run by technological progress.
 What do we learn from macroeconomic analysis?

• A tax cut is not a free lunch.

• Credit markets and banks play key roles in the macroeconomy.
• What consumers and firms anticipate for the future has an important
bearing on current macroeconomic events.
• Money takes many forms, and society is much better off with it than
without it. Once we have it, however, changing its quantity
ultimately does not matter.
• Business cycles are similar, but they can have many causes.
 What do we learn from macroeconomic analysis?

• Countries gain from trading goods and assets with each other, but
trade is also a source of shocks to the domestic economy.
• In the long run, inflation is caused by growth in the money
supply.
• There may be a significant short run tradeoff between aggregate
output and inflation, but aside from inefficiencies caused by long
run inflation, there is no long run tradeoff.
 Understanding Recent and Current
Macroeconomics Events

• Aggregate productivity
• Unemployment and vacancies
• Taxes, Government Spending and the Government
Deficit
• Inflation
• Interest Rates
• Business Cycles in the United States
• Credit Markets and the Financial Crisis
• The Current Account Surplus
Natural Logarithm of Average Productivity
Total Taxes and Total Government Spending
Total Government Surplus
The Inflation Rate and the Money Growth Rate
The Nominal Interest Rate and the Inflation Rate
Real Interest Rate
Relative Price of Housing
Exports and Imports of Goods and Services