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HISTORY OF MACROECONOMICS
• In 1930, there is no macroeconomics – only classical economics (microeconomics).
• When the great depression came, it was not expected nor could be explained – started macroeconomics.
• M. Keynes is the father of macroeconomics – used mathematical models.
• Output – how to measure it?
• Unemployment rate.
• Inflation rate – affects purchasing power.
OBJECTIVES OF MACROECONOMICS
• Low unemployment.
• Low inflation.
• Stable but fast growing economy.
ANATOMY OF ECONOMIES
• There are four major players: households, government, foreigners, firms.
• They meet in three markets: factor, goods, financial.
Have only one good that represents all goods – GDP (gross domestic product).
Definition of GDP
trend (long run)
business cycles (short run)
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Market value of all final goods and services produced within a country in a given period of time.
• Market value: what the price should be.
• of all: legal, commercially sold.
• final: capital and consumption goods, but no intermediate goods.
• Goods and services: both tangible and intangible products.
• produced: reselling doesn’t count.
• within a country: geographical.
• in a given period of time: time constraint (ex: quarterly, yearly).
• Output approach.
• Final good approach:
• Value added approach:
VAGDP. The value added is the value of output minus the value of used
• Demand approach.
• GDP = Private Consumption (C) + Gross Investment (I) + Government Spending (G) + Net Export
• Private Consumption (60-70%): durable goods, nondurable goods, services.
• Gross Investment (15-17%): fixed investment (machinery, building (residential, non-
• Government Spending (15-20%): federal, provincial, local.
• Net Export NX = X – Q (±5%): >0 (trade balance surplus), <0 (trade balance deficit), >0
• Income approach.
• Idea: When output is sold, somebody in the economic earns it.
• GDP ≈ Labor Compensation + Capital Return + Rent
• Doesn’t quite add up to GDP because of indirect taxes and depreciation.
INFLATION AND PRICES
• Nominal GDPt =
tt QP – has both price and quantity in it.
• Real GDPt =
tbQP – based on a base year, and yields the change of aggregate quantity.
• GDP deflator = 100
GDP nomial×, or
= so PYY =$. This is the price of the aggregate good.
• From here, we can calculate the inflation of P – GDP deflator inflation.
Real GDP Growth Ratet = 1001
Cost of Living
• Cost of Living =
btQP – Qb (the bundle) is based in a base year.
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• Note: The bundle contains only household goods and is different from GDP.
• Consumer Price Index: 100
• Civilian Population = Labor Force + Not in Labor Force.
• In symbols,
L is the participation rate.
• Labor Force = Employed + Unemployed.
• In symbols,
E is the unemployment rate.
Economies in the Short Run
• The price level (P) is fixed.
• Capital stock (K) and labor force (L) are fixed.
• The output capacity
LKFY,= is fixed.
• Y can go above or below output capacity
by over-utilization or under-utilization of capital stock and labor
The demand for goods IGCZ
(we assume closed economy, so 0
• Behavioral function for C is
dd YccYCC 10 +== . Since TYYd−= ,
TYccC−+= 10 .
• c0: Autonomous consumption.
• c1: Marginal propensity to consume (MPC).
• We assume the tax function
is a lump sum tax.
• Behavioral function for G is GG =, an exogenous variable.
• Behavioral function for I is
, an exogenous variable.
So finally, IGTYccZ++−+= )(
The supply equation is the sum of all value added Y.
So, by setting
, we can solve for equilibrium GDP.