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ECO102H1 Lecture Notes - Gross Domestic Product, Output Gap, Potential Output

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Michael Ho

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Chapter 19: what macroeconomics is all about?
Macroeconomics: the study of the determination of economic aggregates, such as total output, total
employment, the price level, and the real economic growth.
These aggregates results from activities in many different markets and from the command behaviour of millions
of different decisions maker.
Studying aggregates may cause us to miss important differences but it focuses on retention on some important
issue for the economy as a whole
Moments in economic aggregates matter for most individuals because they influence the help of the industries
in which all worked and the prices of the goods that they purchase.
Macroeconomics considered two different aspects of the economy: one is economists think about the short-run
behaviour of macroeconomic variables such as output, employment, and inflation, and about how government
policy can influence these variables. This concerns among other things, the study of business cycles.
Second is economists also examine the long-run behavior of the same variables specially the long-run have of
aggregate output. This is a study of economic growth and is concerned with explaining how investment and
technological change affect our material living standards over long period of time
A full understanding of macroeconomics acquires understanding the nature of short-run fluctuations as well
as the nature of the long-run economic growth.
There are two different streams of research in macroeconomics. One is researchers takes an approach to
macroeconomics that is based explicitly on microeconomic foundation. These economists to build models of
the economy and that are populated by workers, consumers, and firms, all of whom are assumed to be
optimizers. Having explicitly modeled these agent’s optimization problems, and their resulting choices of work
effort, consumption, an investment, economist proceed to aggregate the choices and these agents to arrive at
the model’s value for and the employment, consumption, output, and so on.
The second group of researchers builds macroeconomic models based only implicitly on these same
microeconomics foundations. This economist construct their models by using aggregate relationship for
consumption, investment, and employment, each of which has been subjected to extensive empirical testing
and is assumed to represent the behavior of the many firms and consumers in this economy
19.1 key macroeconomic variables
Output and income
The most comprehensive measure of a nation’s overall level of economic activity is fair value of its total
production of goods and services called national product.
One of the most important ideas an economics is that the production of output generates income
For the nation as a whole, all of the economic value that is produced ultimately belongs to someone in the form
of an income me on that value.
The term national income to refer to both the value of total output and the value of the income claims
generated by the production of the output
Aggregating total output:
To measure total output, quantities of many different goods are aggregated. To construct such totals, we add
up the values of the different products
We begin by multiplying the number of units of each good produced by the price at which each unit sold. This
yields a dollar value of production for each good, then based on these values across all the different goods
produced in the economy to give us the quantity of total output measured in dollars
Nominal national income: the total national income measured in current dollars. Also called current dollar
national income
A change in this measure can be caused by a change in either the physical quantities are the price on which it is
Real national income: national income measured in constant (base period) dollars. It changes only when
quantities change. It is also called constant-dollar national income
We’ll national income is denoted by the symbol Y and real national income tells us the value of current output
measured at constant price, the sum of the quantities of valued at prices that prevailed in the base period.

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Since prices are held constant mine computing meal national income, changes in their meal national income
from one year to another reflects only changes in quantities.
Comparing real national incomes of different years therefore provides a measure of the change in real output
that has occurred during the intervening period.
National income: recent history
One of the most commonly used to measure of national income is called gross domestic product (GDP), this can
be measured in either real or nominal term.
Business cycle: fluctuations of national income around its trend value that follows a more or less wave like
A single cycle will usually include an interval of quickly growing output, followed by an interval of slowly growing
or even falling output. The entire cycle may last for several years.
No two business cycles are exactly the same, variation occur in duration and magnitude. Some expansions are
long and drawn out. Other comes to an and before high employment and industrial capacity are reached
Potential output and the output gap:
National output with a sense of what the economy actually produces.
An important related concept is potential output, which measures what the economy would produce its all
resources such as land, labor, and productive capacity, were employed at their normal levels of utilization.
Potential output: the real GDP that the economy would produce if its productive resources were employed at
their normal levels of utilization. It is also called the potential GDP or full employment output.
Its symbol is Y* distinguishes itself from actual output indicated by Y. The value of potential output cannot be
measured as precisely as real GDP.
Output gap: an actual national income minus potential national income. Y-Y*
When actual output is less than potential output, (Y<Y*) the gap measures the market value of goods and
services that are not produced because the economy’s resources are not fully employed.
Recessionary gap: a situation in which actual output is less than potential output, (Y<Y*)
When actual output exceeds potential output, (Y>Y*) , the gap measures the market value of production is
excess of what the economy can produce on a sustained basis. Y can exceed Y* because the letter is defined at a
normal rate of utilization of factors of production, and there are many ways in which these normal rates can be
exceeded temporarily.
Inflationary gap: a situation in which actual output exceeds potential output, (Y>Y*)
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