Introduction and aggregate economic activity

Lecture 1 [MACRO]

Economic outcomes

GDP, unemployment rate, inflation rate, interest rates

3 Sector Circular Flow Model

A framework that tracks all the flows of goods/services, factor services, and money between sectors.

Gross Domestic Product (GDP)

The sum of final goods/services. Tells us how much an economy is producing overall.

Gross

Does not subtract depreciation

Domestic

Activity in an economy regardless of ownership.

Product

Refers to one way to measure GDP, as value of production of final goods and services.

What are the 3 ways to measure GDP?

Production (output) approach, expenditure approach, income approach

Production (output) approach

Adds up the market value of all final goods/services produced in each sector, minus the value of intermediate goods (to avoid double counting)

Expenditure approach

Adds up all spending on final goods/services

Income approach

adds up all incomes earned by households and firms from producing goods/services.

Income approach formula

Y = wL + rK
wL = labour income
rK = capital income
(payments to labour/capital that produced them)

Expenditure approach formula

Y = C + I + G + (X-M)
C = private consumption
I = private investment
G = government purchases
X-M = exports - imports

Consumption

Spending by households on goods/services.

• durables

• non-durables

Durables

long-lived goods (cars, furniture)

Non-durables

services and short lived goods (food/clothing)

Investment

Spending by firms on final goods/services.

• business fixed investment

• changes in inventories

• residential investment

Business fixed investment

Capital goods like computers/factories that are not used up in production (unlike intermediate goods)

Changes in inventories

Goods not sold in year of production

Residential investment

Includes newly constructed homes

Government expenditure (purchases)

Expenditure government engages in on final goods/services excluding transfers and interest payments government makes.

Limitations of GDP

• leaves out non-market activity

• may want to value things at other than market prices

• does not account for the depletion of natural resources and the impact of pollution and environmental degradation

• tells us nothing about income distributions

• not a measure of national wellbeing

Nominal GDP

is the total market value of all final goods/services produced in a country during a given period, measured using current prices

Nominal GDP formula

(real GDP) * (GDP deflator)

Real GDP

measures the economy’s actual output - how much stuff is produced - not just how much it costs.

Why we use RealGDP?

NominalGDP tells you how much money the economy is generating, but it doesn’t seperate whether the increase is due to producing more goods or just higher prices (inflation)

GDP levels

refer to the size/value of a country’s economic output in a given period

GDP growth

refers to the rate of change in GDP over time - how much the economy has expanded compared to the previous period