ECON 101B Chapter 2: Chapter 2
Chapter 2: Measuring the Macroeconomy
2.1 Macroeconomic Data
● Most important macroeconomic data is the 6 key variables
Variable
Details
Importance
Real GDP
Rough synonyms include
GNP, NNP, NDP,
notional income,
aggregate demand and
total production
The principal measure of material well-
being and economic productivity
Unemployment rate
As reported omits
“discouraged workers”
who would like to work
but have stopped looking
for jobs
The principal measure of how far
production is falling short of potential
output a measure of the relative
distribution of economic well-being
Inflation rate
Most economists think
officially reported
statistic overstate the true
increase in the nominal
cost of living by 0.5 to
1% per year
The proportion rate of change of the
price level. Central banks today view
their principal mission as ensuring price
stability - keeping the rate of inflation
low enough that nobody worries about it
much
Interest rate
The most important
interest rates are the
“real” (those that control
for the effects of
inflation) and long term
The real long term interest rate is the
principal determinant of the level of
investment and a principal determinant
of future production growth
Stock market
A broad index like S&P is
better than a narrow index
like the Dow-Jones
The stock market summarizes into one
single index a large number of
influences on investment, including
investors’ optimism, expected future
profits, and the real interest rate
Exchange rate
Once again, the most
important rate is the real
rate
The exchange rate determine the
relative price of foreign-made goods in
terms of home-produced goods.
Economists usually work with an index
of the value of the dollar against an
average of all other currencies and call
it exchange rate
2.2 The Exchange Rate
Nominal vs Real Exchange Rates
● Nominal exchange rate (e): the rate at which one country’s money can be turned into
another’s the price of one unit of foreign currency in terms of the home currency
●
● Domestic exporters earn foreign currency when they export, they sell their goods to
people abroad who have foreign currency to pay them. Foreign producers earn domestic
currency when they sell us imports. They sell their goods to people here who have the
domestic currency to pay them
○ Both has a problems. Domestic exporters can’t pay their own domestic workers
with Foreign currency - their workers expect to be paid in the Domestic currency
○ Foreign producers can’t pay their own workers with domestic currency- their
workers expected to be paid in foreign currency hence the exchange rate
○ They solve the problem by turning tin the money they have in exchange for the
money they want (see flow chart above)
The Real Exchange Rate
● Real exchange rate: the real exchange rate is the rate at which goods produced in a
foreign country can be bought or sold for goods produced in the home country ; the price
of foreign produced goods relative to domestic produced goods
● Calculating the real exchange rate
○ To calculate you need to know 3 things: the price level in the home country (P),
prince level abroad (PL) , nominal exchange rate (e)
○ Real exchange rate (E) = ( e * PL ) / P
● Example
○ Supposed that the index of US price level is 120, index of euro-zone is 83.33,
nominal exchange rate is 1.20:$1.20 = 1.00 Euro
■ E = (1.20 * 83.33) / 120 = 0.83
○ Suppose the US rises to 150, euro rises to 120, and nominal value of the euro alls
$1.00 = 1.00 Euro
■ E = (1 * 120) / 150 = 0.80
○ Price of foreign goods in terms of domestic goods (real exchange rate) has fallen
● Calculating the Overall Exchange Rate: Index Numbers
○ Index number: a number that isn’t a set sum, value, or quantity in well defined
units (like dollars, people or percent) but that is a quantity relative to a base year
given an arbitrary index value of 100
2.3 The Stock Market and Interest Rates
The Stock Market
● Def: the market on which the shares of common stock that carry ownership of companies
are bought and sold
● The best and most representative index of US is Standard and Poor’s composite index
akak S&P 500
● Index that is most talked about is Dow-Jones Industrial Average (DJIA), less
representative
● CPI is consumer price index
● The utility of knowledge about the Stock Market
○ Stock: a tradable financial instrument that is a share of ownership of a corporation
■ Investing in stocks you pay the PS price of a stock for each share then the
corporation reports earnings ES per share and some of those earning will
be paid directly to shareholders in the form of dividends
● Rate of return r = ES / PS
● σS : risk premium (greek lowercase sigma and s for stocks)
○ Bond: a tradable financial instrument that is a promise by a business or a
government to repay money that has borrowed
■ A piece of paper that gives you periodic interest payments and at the
bond’s maturity returns you the principal amount of the bond
■ Rate of return of money invested in bonds is the interest payment
○ Investors will want to hold only stocks if
■ ES / PS > r + σS
Document Summary
Most important macroeconomic data is the 6 key variables. Gnp, nnp, ndp, notional income, aggregate demand and total production. Discouraged workers who would like to work but have stopped looking for jobs. The principal measure of material well- being and economic productivity. The principal measure of how far production is falling short of potential output a measure of the relative distribution of economic well-being. Most economists think officially reported statistic overstate the true increase in the nominal cost of living by 0. 5 to. The proportion rate of change of the price level. Central banks today view their principal mission as ensuring price stability - keeping the rate of inflation low enough that nobody worries about it much. Real (those that control for the effects of inflation) and long term. A broad index like s&p is better than a narrow index like the dow-jones.
