Chapter 2: A Tour of the Book

1. INTRODUCING THREE BASIC

MACROECONOMIC CONCEPTS:
Output (and Business Cycles)
Unemployment
Inflation

2. EXAMINE THE EMPIRICAL FACTS

OF THESE MACROECONOMIC
INDICATORS AROUND THE WORLD

Aggregate Output
National income and product accounts are an

accounting system used to measure aggregate

economic activity
The measure of aggregate output in the national

income accounts is gross domestic product, or

GDP

Constructing GDPAn Example of an Economy

with Only Two Firms
Firm 1 produces steel, employing workers and using machines to produce
the steel. It sells the steel for $100 to Firm 2, which produces cars. Firm 1
pays its workers $80, leaving $20 in profit to the firm
Firm 2 buys the steel and uses it, together with workers and machines, to
produce cars. Revenues from car sales are $200. Of the $200, $100 goes
to pay for steel and $70 goes to workers in the firm, leaving $30 in profit
to the firm

What is GDP?
3

$200

GDP: Production and Value Added Approach

There are three ways of defining GDP:
1. GDP is the value of the final goods and services
produced in the economy during a given period
A final good is a good that is destined for final
consumption
An intermediate good is a good used in the production
of another good
Final sales = $200

GDP: Production and Value Added Approach

There are three ways of defining GDP:
2. GDP is the sum of value added in the economy during
a given period

Value added equals the value of a firms production

minus the value of the intermediate goods it uses in
production

(Stage 1 =$100) + (Stage 2 =$100) = $200

GDP: Production and Value Added Approach

There are three ways of defining GDP:
3. GDP is the sum of the incomes in the economy during
a given period

Wages: (firm 1 = $80) + (firm 2 = $70) = $150

Profit: (firm 1 = $20) + (firm 2 = $30) = $50

GDP = $200

THE COMPOSITION OF AUSTRALIAN GDP BY TYPE OF INCOME, 1960 AND 2011

SHARES

1960

2011

Labour income (wages)

70%

55%

Capital income (profit)

23%

35%

7%

10%

Indirect taxes and subsidies

Source: RBA G12; labour income includes mixed
income
6

Nominal and Real GDP

Nominal GDP is the sum of the quantities of final

goods produced times their current price

Nominal GDP increases over time because:
1.
The production of most goods increases over time
2.
The prices of most goods also increase over time

Real GDP is constructed as the sum of the quantities

of final goods times constant (rather than current)

prices
7

Calculating Nominal & Real GDP

An Example
Consider a one good (car) economy in 200911
Nominal GDP = quantity price

Real GDP = quantity price (2010)

Note that Nominal GDP = Real GDP in base year

You can also choose 2009 or 2011 as the base year
the choice is (arguably) arbitrary
the RGDP numbers will obviously be different

Nominal and Real GDP

Nominal GDP is denoted by $Y and also called
dollar GDP or
GDP in current dollars

Real GDP is denoted Y and also called

GDP in terms of goods
GDP in constant dollars
GDP adjusted for inflation, or
GDP in, say, 2010 dollars
The connection between the two is $Y = P Y
9

Australian Nominal and Real GDP 1960-2015

Nominal GDP increased by a factor of 3.59 (=14932/4156)

Real GDP increased by a factor of 1.92 (=118230/61709)
10

(Real) GDP Growth

GDP growth equals:

Yt Yt 1
Yt 1

Example: year-ended GDP growth

Y2015 Y2014 410.7 400.8

0.025 or 2.5%
Y2014
400.8
Periods of positive GDP growth are called expansions
Periods of negative GDP growth are called recessions
Phases of expansions and recessions inform us about
the business cycles of the economy
11

Australian

12

World Economic Growth

13

The Unemployment Rate

labour force = employed + unemployed
L
=
N
+
U

U
u
L

Unemployment rate:

Australia
April 2016

Employed
11.9 million

u Apr /2016

0.72

5.7%
0.72 11.9

Unemployment rate was 6.2% in April 2015

Unemployed
0.72 million

14

The Unemployment Rate

Only those looking for work are counted as unemployed.

Those not working and not looking for work are not in the
labour force
People without jobs who give up looking for work are known
as discouraged workers
Participation rate

labour force

population of working age

15

16

Unemployment Rate (LHS scale)

Participation Rate (RHS scale)
1/31/15

5/31/13

9/30/11

1/31/10

5/31/08

9/30/06

1/31/05

5/31/03

9/30/01

1/31/00

5/31/98

9/30/96

1/31/95

5/31/93

9/30/91

1/31/90

5/31/88

9/30/86

1/31/85

5/31/83

9/30/81

6/2/05

In Australia
12
68

11
67

10
66

9
65

8
64

7
63

6
62

5
61

4
60

3
59

Around the World: G3

17

 Why do macroeconomists care about

unemployment?

Economists care about unemployment for two reasons:

Unemployment

has important social consequences

The unemployment rate gives them an indication of whether an
economy is operating above or below its normal level of activity

18

Dig A Little Deeper

Global Youth Unemployment: 1995-2015

19

The Inflation Rate

Inflation is a sustained rise in the general level of

pricesthe price level

Two common measures are the GDP deflator and

Consumer Price Index (CPI)

The inflation rate is the rate at which the price

level increases

Disinflation is the decrease in the rate of inflation,e.g., 3%

2%

prices still rise, but now at a slower rate

Deflation is a sustained decline in the price level,

or a negative inflation rate, e.g., -1%

prices everywhere are falling

20

Index Number of The General Price Level

The myriad of prices observed in the economy is compressed

into an index number for each period (month, quarter, or

year)
The value of the index number is set to 100 for the base
period (it is arbitrary in nature)
For example:

2013: 98
2014 (base year): 100
2015: 102

The index number itself (in levels) is not very interesting,

what we are more interested is the % change in the index

number, i.e., calculating the rate of inflation
Both GDP deflator and CPI are expressed in terms of index
numbers
21

The GDP Deflator

nominal GDPt $Yt
Pt

real GDPt
Yt
The rate of change in the GDP deflator equals the rate of

inflation:

( Pt Pt 1 )
Pt 1

Example:

P2015 P2014 102 100

0.02 or 2%
P2014
100
22

The Consumer Price Index

The GDP deflator measures the average price of

(domestically produced) output

While the consumer price index (CPI) measures the
average price of consumption, or equivalently, the
cost of living

the calculation of inflation based on CPI is the same as that of

the GDP deflator
the CPI and the GDP deflator move together most of the time

23

Australian Inflation 1961-2014

20.00
18.00

16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00

-2.00

PGDP inflation

CPI inflation

Why do they differ in the 2000s?

24

25

 Why do macroeconomists care about inflation?

Economists care about inflation for at least two reasons:
It

affects relative prices (e.g., the real wage) and thus income
distribution
It creates other distortions
changes in relative prices create uncertainty and affect decision
making
inflation can affect taxes through tax bracket creep

Pure inflation:

W 5%
P 5%

Change in relative price:

W

P

W 5%

P 10%
26

0%

W

P

5%

Okuns Law
Output growth is negatively related to the change in the
unemployment rate

27

Phillips Curve
The change in the inflation rate is negatively related to the
unemployment rate

28

A Successful Economy
A successful economy combines
high output growth
low unemployment
low inflation

Can all these objectives be achieved simultaneously?

Is low unemployment compatible with low and stable
inflation?
Do policy makers have the tools to sustain growth, to achieve
low unemployment while maintaining low inflation?
These are the key questions of macroeconomics
29

The Short Run, the Medium Run,

the Long Run
Output is determined by:

demand in the short run, say, up to a few years

the level of technology, the capital stock, and the labour
force in the medium run, say, up to a decade or so
the dynamics from the short run to the medium run are our focus
in ECON202

factors such as education, research, saving, and the

quality of government in the long run, say, a half
century or more
30