Macroeconomics Notes

National Income Accounting

• Measures flows of income and expenditures over time.
• Simplified representation: Circular-Flow Model.

Circular-Flow Diagram

• Two decision-makers: households and businesses.
• Seller receives the same amount the buyer spends.
• Goods/services flow one way, money the other way.
• Product Markets
  • Households: demand side.
  • Businesses: supply side.
  • Interaction determines price.
  • Businesses provide goods/services to households, who pay with money.
  • $value \ of \ output = total \ monetary \ value \ of \ all \ final \ goods \ and \ services$
• Factor Markets
  • Households supply resources.
  • Businesses demand resources.
  • Interaction determines resource price/income.
  • Households "sell" resources to businesses, who pay wages, rent, interest, profits (Total Income).
  • $Total \ income = wages + rents + interest + profits$

Expanded Circular-Flow Diagram

• Includes government purchases, taxes, borrowing, transfers, private savings, investment spending, exports, imports, financial markets and the rest of the world.

Gross Domestic Product (GDP)

• Total market value of all final goods/services produced within a country in one year.
• Nominal GDP (FY24, USA): $29.7 Trillion$
• Computes value, not just production.
• Avoids double counting by eliminating intermediate goods.
• Counts goods produced within a country, regardless of company HQ.
• Sums dollar value of production over the year, not sales.

Calculating GDP

• Survey firms and add up the total value of their production of final goods and services.
• Sum the total factor income earned by households from firms in the economy (Income Approach).
• Add up aggregate spending on domestically produced final goods and services (Expenditure Approach).

Components of GDP

• $GDP = C + I + G + X$
  • C (Consumption): Household purchases of final goods/services.
    • Durable & Nondurable Consumer Goods & Services
  • I (Gross Private Domestic Investment): Spending on inventories,
    • new capital goods, and new homes.
  • G (Government Expenditures): Government consumption and investment (state, local, federal).
  • X (Net Exports): Exports minus imports.

GDP: What’s In and What’s Out?

• Excludes intermediate goods, inputs, used goods, transfer payments, financial assets, and foreign-produced goods/services.

What GDP Tells Us

• Provides a scale to compare economies over time and across countries.
• Nominal GDP: GDP calculated at existing prices.
  *Real GDP: Nominal GDP adjusted for inflation.
  *Formula: $Real \ GDP = \frac{Nominal \ GDP}{Price \ Index} \cdot 100$
• Economic Growth measured by Real GDP growth rate: $Growth \ Rate = \frac{Year \ 2 - Year \ 1}{Year \ 1} - 1$
• Per capita real GDP: Adjusting for population growth
• Formula: $Per \ capita \ real \ GDP = \frac{Real \ GDP}{Population}$

The Unemployment Rate

• Unemployed: Actively seeking work but not employed.
• Labor Force: Employed + Unemployed (160.16 million in Jan. 2021).
• Formula: $Labor \ Force = Employed + Unemployed$
  *Unemployment Rate Formula: $Unemployment \ Rate = \frac{Unemployed}{Labor \ Force} \cdot 100$
• Categories of Individuals Without Work:
  • Job loser
  • Reentrant
  • Job leaver
  • New entrant
• Problems with the Unemployment Rate:
  • Overstates: normal for job-seekers to take time.
  • Understates
    • Excludes discouraged, marginally attached, and underemployed workers.
    • Varies among demographic groups.

Causes and Categories of Unemployment

• Frictional Unemployment: Workers moving between jobs.
• Structural Unemployment: Mismatch of skills and employer needs.
  • Technological advances, shifts in tastes, decline of resources, seasonal patterns, minimum wage increases.
• Cyclical Unemployment: Results from recessions and economic downturns.
• The Natural Rate of Unemployment
  • When cyclical unemployment is zero.
  • $Natural \ rate \ of \ unemployment = Frictional \ unemployment + Structural \ unemployment$
  • $Actual \ rate \ of \ unemployment = Natural \ unemployment + Cyclical \ unemployment$
  • New unions can increase structural unemployment.
  • Temporary employment agencies and job-placement websites can decrease frictional unemployment.
  • A high minimum wage can increase structural unemployment.
  • Generous unemployment benefits can increase both structural and frictional unemployment.
  • Job training and employment subsidies may decrease structural and frictional unemployment.

Inflation and Deflation

• Inflation: Average prices rising.
• Deflation: Average prices falling.
• Inflation Rate: Percentage increase in the overall level of prices per year.
• Formula: $Inflation \ Rate = \frac{Price \ Level \ in \ Year \ 2 - Price \ Level \ in \ Year \ 1}{Price \ Level \ in \ Year \ 1} - 1$
• "Costs" of Inflation:
  • Shoe-Leather Costs: Discourages holding money.
  • Menu Costs: Firms must change prices often.
  • Unit-of-Account Costs: Reduces the quality of economic decisions.
    *The value of money is typically talked about in terms of purchasing power
    *Nominal value: price expressed in today’s dollars
    *Real value: value expressed in purchasing power, adjusted for inflation
• Unanticipated Inflation: Surprise inflation.
• Anticipated Inflation: Expected inflation.
  *Nominal Rate of Interest: The market rate of interest expressed in today’s dollars
  *Real Rate of Interest: The nominal interest rate adjusted for inflation (nominal interest rate minus the inflation rate)
• When inflation is higher than anticipated:
  • Creditors lose.
  • Debtors gain.
    *Banks attempt to protect themselves by raising nominal interest rates to reflect anticipated inflation
    *Workers attempt to protect themselves with Cost of Living Adjustments (COLAs)

Measurement and Calculation of Inflation

• Price Index: Cost of today’s market basket as a percentage of the base year cost.
  • Formula: $Price \ index = \frac{Cost \ today \ of \ market \ basket}{Cost \ of \ market \ basket \ in \ base \ year} \cdot 100$
• Consumer Price Index (CPI)
  • Average change over time in a fixed basket of goods.
  • Most common inflation indicator.
• Producer Price Index (PPI)
  • Average change over time in production costs. Used as a short-run leading indicator.
• GDP Deflator
  • Price index measuring changes in prices of all new goods/services produced.
  • Broadest measure; reflects price and market responses.