macro

Two branches of economics:

• Microeconomics: Decision-making by households and firms

• Macroeconomics: Economy-wide phenomena (e.g., inflation, unemployment, growth)

Circular-Flow Diagram:

• Firms: Use factors of production

• Households: Own factors of production

Factors of Production:

1. Land

2. Labor

3. Capital

4. Entrepreneurship

Market Dynamics:

• Goods and Services: Households (buyers) and firms (sellers)

• Factors of Production: Households sell; firms buy

Gross Domestic Product (GDP):

• Measures total income and expenditure: Income = Expenditure

• Market value of final goods & services produced, excluding:

  • Illegal goods/services

  • Home-produced goods

Key GDP Attributes:

• Focus on final goods only

• Reflects current production

• Includes all production within boundaries

• Generally reported annually/quarterly

Active Learning Concepts:

• Transactions impact GDP (e.g., lawn mowing $50).

• Marital status changes might exclude non-market household services from calculations.

• Components of GDP:

  • Consumption (C): Total household spending on goods and services (excludes new housing purchases).

  • Investment (I): Spending on goods for future production (includes business capital, residential capital, inventory).

  • Government Purchases (G): Spending by government on goods and services (excludes transfer payments).

  • Net Exports (NX): Exports minus imports.

GDP Formula:

• $Y = C + I + G + NX$

Real vs Nominal GDP:

• Nominal GDP: Values output using current prices (not inflation adjusted).

• Real GDP: Values output using prices from a base year (inflation adjusted).

GDP Deflator:

• Formula: $GDP \, deflator = 100 \times \frac{nominal \ GDP}{real \ GDP}$

• Reflects the current price level compared to a base year.

Limitations of GDP as a Measure of Well-Being:

• Does not account for environmental quality, leisure time, or equitable income distribution.

• Indicates economic capacity but not social well-being.

Significance of GDP:

• Higher GDP correlates with improved living standards, education quality, and healthcare access.

Consumer Price Index (CPI): Measures overall cost of goods/services; tracks cost of living changes.

Core CPI: Excludes food/energy prices to measure cost of consumer goods/services.

Producer Price Index (PPI): Measures cost of a basket of goods/services bought by firms.

CPI Calculation Steps

1. Fix the basket: Determine typical consumer's shopping basket.

2. Find prices: Collect prices of goods in the basket.

3. Compute the basket cost: Calculate total cost.

4. Choose base year; compute CPI:
   $CPI = \left( \frac{\text{Basket’s cost in current year}}{\text{Basket’s cost in base year}} \right) \times 100$

5. Compute inflation rate:
   $\text{Inflation rate} = \frac{CPI\text{ this year} - CPI\text{ last year}}{CPI\text{ last year}} \times 100$

Real vs. Nominal Interest Rates

• Nominal Interest Rate: Growth in dollar value (not adjusted for inflation).

• Real Interest Rate: Measures growth in purchasing power:
  $\text{Real interest rate} = \text{Nominal interest rate} - \text{Inflation rate}$

Indexation

• Definition: Automatic adjustment of amounts based on inflation;