Gross Domestic Product (GDP): Dollar value of final output produced during a given
period of time within the borders of Canada.
3 approaches to measuring GDP:
• Product Approach: sum of value added to goods and services in production
across all productive units in the economy.
o Total revenue – wages – interest – cost of intermediate inputs – taxes
• Expenditure Approach: C + I + G + NX
• Income Approach: Y = C + I + G + NX
GNP: Measures the value of output produced by domestic factors of production,
whether or not the production takes place inside Canadian borders.
Components of Aggregate Expenditure:
• Consumption: 55.5% of GDP 2007
o Durable goods, semi-durable goods, nondurable goods, and services.
• Investment: 20.3% of GDP in 2007
o Fixed investments: production of Capital: Plant, equipment, and housing
o inventory invesmtnet: Goods put in storage.
• Net Exports: 1.9%
• Government Expenditures: 22.7%
Price Index: Weighted average of the prices of a set of the goods and services produced in the
economy over a period of time.
Price Level: average level of prices across all goods and services.
Inflation: one change from a period to another.
• Nominal change: Change in GDP occurring only because price level
• Real Change: increase in physical quantity of output.
Real GDP: value of final goods and services produced in a given year when valued at
Implicit GDP Deflator: Nominal GDP/Real GDP x100
CPI: Fixed weight Price index Current Year
CPI=Cost of base year quantities at current prices/cost of base year quantities at base
year prices x100
Capital Stock: The quantity broad of plant, equipment, housing, and inventories in
existence in an economy at a point in time.
Labour market measurement:
• Employed: 15 and older who worked part-time or full time during past week.
• Unemployed: 15 and older who were not employed during the past week, but
actively searched for work at some time during the last four weeks.
• Labour Force=Employed + Unemployed
• Not in labour force: 15 and older who are neither employed nor unemployed.
• Unemployment Rate: Fraction of the labour force that is unemployed. o UR = Unemployed/Labour Force
• Participation rate: Labour Force/Total working age population
• Employment/population ratio: Employment/Total Working age population
• Labour market tightness: reflects the degree of difficulty that firms face in hiring
Business Cycles: fluctuations about trend in real gross domestic product.
Amplitude: Maximum in trend.
Frequency: Number of peaks that occur per year.
Boom: Series of positive deviations from trend.
Recession: Series of negative deviations from trend.
Peaks: large positive deviation from trend
Through: relatively large negative deviation from trend
Comovement describes how aggregate economic variables move together over the business
• Positive Correlation/procyclical
• Negative Correlation/countercyclical
• Leading/Lagging Variables
• Coincident variable: neither lags nor leads.
Philips Curve: negative relationship among change of money wages, and unemployment rate
in the UK.
If we take the unemployment rate to be a measure of aggregate economic activity then
the Philips curve captures positive relationship between the rate of change in a money
price and the level of aggregate economic activity. They tend to be unstable.
Labour Market Variables:
Real Wage: purchasing power of the wage earned per hour worked for the average worker.
Measured as: average money wage for all workers/Price Level. Weight of empirical rule
suggests that real wage is procyclical.
Average Labour productivity: Y/N | Y=aggregate real output N=Total Labour Input
• Average labour productivity as output per worker.
Static Decisions: Given that there is only one time period
Dynamic: Planning over more than one period. The Representative Consumer:
• Consumer’s preferences over leisure and consumption goods is described by a
utility function, U(C,l)
• 3 features:
o More is always preferred to less
o The consumer likes diversity in their consumption bundle
o Consumption and leisure are normal goods.
Indifference map: Graphical representation of the utility function. Family of indifference curves.
Indifference curve: set of consumption bundles among which the consumer is indifferent.
Marginal Rate of Substitution:
• marginal rate of substitutionis the rate at which the consumer is willing to substitute
leisure for consumption goods
• It is the negative of the slope of the indifference curve---that is,
o MRS = -[Slope of the indifference curve passing through (C,l)]
• Explains relationship between the marginal
rate of substitution and the slope of the
The Budget Constraint:
• Condition that the total expenditure on consumption goods and leisure must not exceed
the real disposable income. • If w is the real wage rate, h is the total number hours available for work, π is the dividend
income, and T is the lump-sum tax amount then:
o C + wl = wh +π - T
• the figure is the graphical
representation of the consumer’s
• Negative of the slope of the budget
line, w, is the trade-off between
consumption and leisure.
• Optimal commodity bundle: Consumption-leisure pair that is feasible and lies on the
highest possible indifference curve.
• The optimal consumption leisure pair meets the condition: MRS = l,c
Figure shows the optimal
consumption-leisure pair, represented
by point H
The consumer finds such a pair by
equating the marginal rate of
substitution of leisure for consumption
MRS I,Co the relative price of leisure
Effects of change in Dividends or Taxes:
• Given w, an increase in the net of tax dividend (π - T) produces a pure income effect on
the consumer’s choices.
• It expands the consumers feasibility set
• Given that consumption & leisure are normal goods, increase in (π -T) increases both
consumption & leisure.
Income Effect: Figure shows the effects of an increase in (π – T)
The optimal consumption-leisure pair moves from
point H to K
• At point K, both consumption
& leisure are higher.
• Increased leisure menas less
• The new optimal bundle lies
on a higher indifference curve
indicating an increase in
Effects of Changes in the Real Wage
• Given (π-T), an increase in the real wage produces an income effect and a substitution
• Substitution effect increases consumption but reduces leisure.
• The income effect raises both consumption and leisure.
• Thus, while consumption increases in response to an increase in the real wage, leisure
may or may not.
Income & Substitution Effects:
Figure shows the effects
of an ncr